**EXHIBIT13**

 

 

# ***Raising Banking to the Power of Business****Ò*

# ** **

### **Annual Report**

### ** **

**2008**

 

#### 1804West StreetAnnapolis, MD 21401**www.commerce1st.com**

 

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April 6, 2009

 

To our FellowShareholders:

 

The increasing headwindscaused by numerous serious shocks to our financial system and deterioratingeconomy created disappointing operating results for most banks in 2008, and weare no exception. Core earnings were greatly impacted by rapidly declininginterest rates that lowered asset yields at a much greater pace than ourability to re-price deposit liabilities. Also, as it became evident thatincreasingly broad economic deterioration would also eventually affect ourlocal business banking model, management significantly increased reserves toaddress any potential loss exposure to weakening borrowers.

 

We did seizeopportunities to win new business from struggling large bank competition. Totalasset and loans continued to grow during 2008 and the Company continues toexperience strong loan demand for commercial loans and commercial real estateloans. The expected increase in interest income from our loan portfolio did notmaterialize because of the effect of the rapid reduction in market interestrates which reduced our earnings on adjustable rate loans and short term investments.  Key measurements and events for the yearended December 31, 2008 include the following:

 

·                  Totalassets as of December 31, 2008 increased by 12.0% to $167 million ascompared to $149 million as of December 31, 2007.

 

·                  Netloans outstanding increased by $26 million, or 21.2% to $151 million as of December 31,2008 from $125 million as of December 31, 2007.

 

·                  Depositsas of December 31, 2008 were $145 million, an increase of $22 million or17.7% from December 31, 2007.

 

·                  TheCompany’s net income decreased to $295 thousand, or 72.9%, for the year ended December 31,2008 as compared to net income of $1.1 million for the year ended December 31,2007.

 

Earnings were adverselyinfluenced by the decline in the Company’s net interest margin and increasedprovision for loan losses. Market interest rates dropped sharply as the FederalReserve Bank reduced interest rates rapidly to improve liquidity in the bankingindustry and to address deteriorating economic conditions. Loan loss expensewas higher as the result of the current economic environment’s adverse effecton some of our borrowers. We continue to closely monitor our loan portfolio foradverse effects from the weakened economy. At the same time, we continue tosearch for prudent lending opportunities to continue the growth of the Company.We are optimistic that our strong capital base, hands-on management approach tocommercial lending, and continued measured growth path, will position us as astrong competitor when the economy gradually recovers.  Although fiscal 2009 will likely be anotherchallenging year for the financial industry, we are confident we arewell-poised to weather current storms and can emerge from them a stronger andmore profitable institution.

 

As always we appreciateyour continued support of our bank through your referrals and patronagethroughout 2008.

 

Very truly yours,

 

 
| Milton D. Jernigan II |   | Richard J. Morgan |
|-----------------------|--------|-------------------|
| Chairman of the Board |   | President and CEO |

 

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**SELECTED CONSOLIDATED FINANCIAL DATA**

 

Thefollowing table shows selected historical consolidated financial data forCommerceFirst Bancorp, Inc. You should read it in conjunction with thehistorical consolidated financial information contained in the ConsolidatedFinancial Statements for the year ended December 31, 2008 included in thisAnnual Report. Data for the years ended December 31, 2008, 2007, 2006,2005 and 2004 are derived from the audited consolidated financial statements.

 
| ** **                                                                       | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| **(Dollars in thousands, except per share data.)** | ** ** | **2008**                                   | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Operation  Statement Data:**                                                   |       |                                       |       |   |   |   |   |   |   |   |   |
| Net interest  income                                                             |       | $                                          | 5,567      |   | $ | 5,895 |   | $ | 5,301 |   | $ | 4,200 |   | $ | 2,412 |   |
| Provision for  loan losses                                                       |       | $                                          | 647        |   | $ | 45 |   | $ | 225 |   | $ | 360 |   | $ | 590 |   |
| Noninterest  income                                                              |       | $                                          | 569        |   | $ | 620 |   | $ | 633 |   | $ | 625 |   | $ | 584 |   |
| Noninterest  expense                                                             |       | $                                          | 5,028      |   | $ | 4,688 |   | $ | 3,652 |   | $ | 2,773 |   | $ | 2,179 |   |
| Federal and  state income tax (expense) benefit                                  |       | $                                          | (166       | ) | $ | (694 | ) | $ | (774 | ) | $ | (658 | ) | $ | 862 |   |
| **Net  income**                                                                  |       | $                                          | 295        |   | $ | 1,088 |   | $ | 1,283 |   | $ | 1,033 |   | $ | 1,090 |   |
|                                                                             |       |                                       |       |   |   |   |   |   |   |   |   |
| **Per  share data and shares outstanding:**                                      |       |                                       |       |   |   |   |   |   |   |   |   |
| Net income per  share, basic                                                     |       | $                                          | 0.16       |   | $ | 0.60 |   | $ | 0.71 |   | $ | 0.63 |   | $ | 1.33 |   |
| Net income per  share, diluted                                                   |       | $                                          | 0.16       |   | $ | 0.59 |   | $ | 0.69 |   | $ | 0.62 |   | $ | 1.33 |   |
| Book value at  period end                                                        |       | $                                          | 11.16      |   | $ | 11.02 |   | $ | 10.36 |   | $ | 9.63 |   | $ | 8.24 |   |
| Average common  shares outstanding during year                                   |       | 1,820,548                                  |       | 1,816,504 |   | 1,803,583 |   | 1,647,645 |   | 822,250 |   |
| Diluted average  common shares outstanding during year                           |       | 1,820,548                                  |       | 1,848,195 |   | 1,846,462 |   | 1,672,928 |   | 822,250 |   |
| Shares  outstanding at period end                                                |       | 1,820,548                                  |       | 1,820,548 |   | 1,803,583 |   | 1,803,583 |   | 822,250 |   |
|                                                                             |       |                                       |       |   |   |   |   |   |   |   |   |
| **Financial  Condition data:**                                                   |       |                                       |       |   |   |   |   |   |   |   |   |
| Total assets                                                                     |       | $                                          | 166,569    |   | $ | 148,811 |   | $ | 141,270 |   | $ | 112,545 |   | $ | 75,953 |   |
| Loans receivable  (net)                                                          |       | $                                          | 151,101    |   | $ | 124,670 |   | $ | 95,081 |   | $ | 75,044 |   | $ | 51,776 |   |
| Allowance for  loan losses                                                       |       | $                                          | 1,860      |   | $ | 1,665 |   | $ | 1,614 |   | $ | 1,615 |   | $ | 1,154 |   |
| Other  interest-earning assets                                                   |       | $                                          | 9,227      |   | $ | 18,358 |   | $ | 40,121 |   | $ | 31,985 |   | $ | 19,180 |   |
| Total deposits                                                                   |       | $                                          | 145,241    |   | $ | 123,408 |   | $ | 112,205 |   | $ | 88,167 |   | $ | 65,729 |   |
| Borrowings                                                                       |       | $                                          | —     |   | $ | 4,306 |   | $ | 9,579 |   | $ | 6,010 |   | $ | 3,086 |   |
| Stockholders’  equity                                                       |       | $                                          | 20,311     |   | $ | 20,056 |   | $ | 18,687 |   | $ | 17,363 |   | $ | 6,774 |   |
|                                                                             |       |                                       |       |   |   |   |   |   |   |   |   |
| **Selected  performance ratios:**                                                |       |                                       |       |   |   |   |   |   |   |   |   |
| Return on  average earning assets                                                |       | 0.25                                       | %          | 1.07 | % | 1.23 | % | 1.19 | % | 2.05 | % |
| Return on  average equity                                                        |       | 1.92                                       | %          | 7.47 | % | 7.16 | % | 6.76 | % | 18.02 | % |
| Net interest  margin(1)                                                          |       | 3.59                                       | %          | 4.38 | % | 5.06 | % | 4.86 | % | 4.58 | % |
| Net interest  spread(2)                                                          |       | 2.60                                       | %          | 3.10 | % | 3.83 | % | 4.01 | % | 4.11 | % |
| Efficiency  ratio(3)                                                             |       | 81.94                                      | %          | 72.21 | % | 61.56 | % | 57.47 | % | 60.79 | % |
|                                                                             |       |                                       |       |   |   |   |   |   |   |   |   |
| **Asset  quality ratios:**                                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Nonperforming  loans to gross loans                                              |       | 3.80                                       | %          | 0.89 | % | 0.65 | % | 0.77 | % | 2.00 | % |
| Allowance for  loan losses to loans                                              |       | 1.22                                       | %          | 1.32 | % | 1.67 | % | 2.10 | % | 2.18 | % |
| Allowance for  loan losses to nonperforming loans                                |       | .28                                        | x          | 1.48 | x | 2.57 | x | 2.73 | x | 1.09 | x |
| Nonperforming  assets to loans and other real estate                             |       | 3.80                                       | %          | 0.89 | % | 0.65 | % | 0.77 | % | 2.00 | % |
| Net loan  charge-offs (recoveries) to average loans                              |       | 0.33                                       | %          | 0.00 | % | 0.26 | % | (0.15 | )% | 0.10 | % |
|                                                                             |       |                                       |       |   |   |   |   |   |   |   |   |
| **Capital  ratios:**                                                             |       |                                       |       |   |   |   |   |   |   |   |   |
| Total risk-based  capital ratio                                                  |       | 14.14                                      | %          | 16.48 | % | 19.10 | % | 22.50 | % | 13.52 | % |
| Tier I  risk-based capital ratio                                                 |       | 12.91                                      | %          | 15.23 | % | 17.84 | % | 21.20 | % | 12.26 | % |
| Leverage ratio                                                                   |       | 12.24                                      | %          | 13.91 | % | 15.10 | % | 17.30 | % | 10.58 | % |
| Average equity  to average assets                                                |       | 12.86                                      | %          | 13.93 | % | 16.63 | % | 17.05 | % | 10.97 | % |

 

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| (1) Net interest margin is net interest income  divided by average earning assets.                                                                     |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) Net interest spread is the difference  between the average yield on interest earning assets and the average cost of  interest bearing liabilities. |
| (3) Efficiency ratio is noninterest expense  divided by the sum of net interest income and noninterest income.                                         |

 

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**MANAGEMENT’SDISCUSSION AND ANALYSIS**

 

Forward LookingStatements. Certain information contained in this discussion may include “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934,as amended. These forward-looking statements are generally identified by wordssuch as “may,” “anticipates,” “believes,” “expects,” “plans,” “estimates,” “potential,”“continue,” “should,” and similar words or phrases. Such forward-lookingstatements involve known and unknown risks including, but not limited to,changes in general economic and business conditions, interest ratefluctuations, competition within and from outside the banking industry, newproducts and services in the banking industry, risk inherent in making loanssuch as repayment risks and fluctuating collateral values, problems withtechnology utilized by the Company, changing trends in customer profiles andchanges in laws and regulations applicable to the Company.  Although the Company believes that itsexpectations with respect to the forward-looking statements are based uponreliable assumptions within the bounds of its knowledge of its business andoperations, there can be no assurance that actual results, performance orachievements of the Company will not differ materially from any future results,performance or achievements expressed or implied by such forward-lookingstatements.  Readers are cautioned againstplacing undue reliance on any such forward-looking statements. The Company doesnot undertake to update any forward-looking statements to reflect occurrencesor events that may not have been anticipated as of the date of such statements.

 

Thisdiscussion and analysis provides an overview of the financial condition andresults of operations of CommerceFirst Bancorp, Inc. (the “Company”) andCommerceFirst Bank (the “Bank”) for the years 2008 and 2007.  It is intended that this discussion andanalysis help the readers in their analysis of the accompanying auditedConsolidated Financial Statements. You should read this discussion inconjunction with the Consolidated Financial Statements and Notes theretoprovided elsewhere in this report.

 

##### **General**

##### ** **

CommerceFirst Bancorp, Inc.is the bank holding company for CommerceFirst Bank, a Maryland charteredcommercial bank headquartered in Annapolis, Maryland. The Bank was capitalized,became a wholly owned subsidiary of the Company and commenced operations on June 29,2000. The Company maintains five banking offices in Anne Arundel, Howard andPrince George’s counties in central Maryland. The Company focuses on providing commercial banking services to smalland medium sized businesses in its market areas.

 

During2008, the financial industry encountered significant volatility and stress aseconomic conditions worsened, unemployment increased and the effects of the “mortgagecrisis” became more widespread.  Whilethe Company did not have direct exposure to the subprime mortgage issues inthat it did not make residential mortgage loans, and did not invest in mortgageback securities or the preferred stock of Freddie Mac and Fannie Mae, theslowing economy, declines in housing construction and the related impact oncontractors and other small and medium sized businesses, has had an adverseimpact on the Company’s business. This impact included increased levels ofnon-performing assets, loan charge-offs and loan loss provisions.  Additionally the steep reductions in thefederal funds target rate, from 4.25% at December 31, 2007 to 2.00% at September 30,2008 and 0.25% at December 31, 2008, intended to stimulate liquidity andstabilize the financial system, adversely impacted the Company’s interestmargin.  While the Company believes thatit has taken adequate reserves for the problem assets in its loan portfolio at December 31,2008, and that the impact of margin pressure can be managed, there can be noassurance that the Company will not be required to take additional charge-offsor make additional provisions for nonperforming loans, that currentlyperforming loans will continue to perform, or that the Company will be able toachieve cost savings on deposits as higher costing certificates of depositsmature.  Additionally, there can be noassurance that the steps taken to stimulate the economy and stabilize thefinancial system will prove successful, or that they will improve the financialcondition of the Company’s customers or the Company.

 

**Overview**

 

TheCompany continued a pattern of asset growth during the year ended December 31,2008. However, rapid reductions in market interest rates during 2008 haveoffset the effect of the asset growth resulting in lower revenues than in theprior period. Key measurements and events for the year ended December 31,2008 include the following:

 

·                  Totalassets as of December 31, 2008 increased by 12.0% to $167 million ascompared to $149 million as of December 31, 2007.

 

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·                  Netloans outstanding increased by $26 million, or 21.2% to $151 million as of December 31,2008 from $125 million as of December 31, 2007.

 

·                  Depositsas of December 31, 2008 were $145 million, an increase of $22 million or17.7% from December 31, 2007.

 

·                  TheCompany’s net income decreased to $295 thousand, or 72.9%, for the year ended December 31,2008 as compared to net income of $1.1 million for the year ended December 31,2007.

 

·                  Netinterest income, the Company’s main source of income, was $5.6 million duringthe year ended December 31, 2008 compared to $5.9 million for the sameperiod in 2007. This represents a decrease of 5.6% for the year December 31,2008 as compared to 2007.

 

·                  Theprovision for loan losses increased from $45 thousand in 2007 to $647 thousandin 2008 reflecting increased provisions for loan losses.

 

Adetailed discussion of the factors leading to these changes can be found in thediscussion below.

 

## **CriticalAccounting Policies**

## ** **

TheCompany’s consolidated financial statements are prepared in accordance withaccounting principles generally accepted in the United States and followgeneral practices within the industries in which it operates.  Application of these principles requiresmanagement to make estimates, assumptions and judgments that affect the amountsreported in the financial statements and accompanying notes.  These estimates, assumptions and judgmentsare based on information available as of the date of the financial statements;accordingly, as this information changes, the financial statements could reflectdifferent estimates, assumptions and judgments. Certain policies inherently have a greater reliance on the use ofestimates, assumptions and judgments and as such have a greater possibility ofproducing results that could be materially different than originallyreported.  Estimates, assumptions andjudgments are necessary when assets and liabilities are required to be recordedat fair value, when a decline in the value of an asset not carried on thefinancial statements at fair value warrants an impairment write-down orvaluation reserve to be established, or when an asset or liability needs to berecorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in morefinancial statement volatility.  The fairvalues and the information used to record valuation adjustments for certainassets and liabilities are based either on quoted market prices or are providedby other third-party sources, when available.

 

Themost significant accounting policies followed by the Company are presented inNote 1 to the consolidated financial statements. These policies, along with thedisclosures presented in the other financial statement notes and in thisdiscussion, provide information on how significant assets and liabilities arevalued in the financial statements and how those values are determined.  Based on the valuation techniques used andthe sensitivity of financial statement amounts to the methods, assumptions andestimates underlying those amounts, management has identified the determinationof the allowance for loan losses as the accounting area that requires the mostsubjective or complex judgments, and as such could be most subject to revisionas new information becomes available.

 

The Company believes ithas developed appropriate policies and procedures for assessing the adequacy ofthe allowance for loan losses, recognizing that this process requires a numberof assumptions and estimates with respect to its loan portfolio.  The Company’s assessments may be impacted infuture periods by changes in economic conditions, the impact of regulatoryexaminations and the discovery of information with respect to borrowers whichis not known to management at the time of the issuance of the consolidatedfinancial statements.  For additionaldiscussion concerning the allowance for loan losses and related matters, see “*Provision for Loan Losses*” below and Note1 to the consolidated financial statements.

 

**FinancialCondition**

 

The Company’s assets at December 31,2008 were $166.6 million, an increase of $17.8 million or 12.0%, from December 31,2007. The increase is primarily the result in the increase in loans of $26.4million offset by the decrease in cash and cash equivalents of $2.7 million anda decrease in investment securities of $6.1 million. The Company funded the increasein loans through increased deposits and the use of excess liquidity during2008.

 

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**Loan Portfolio**

 

At December 31,2008, loans totaled $151.1 million as compared to loans of $124.7 million at December 31,2007. The loan portfolio is comprised of commercial loans and real estateloans. The majority of the increase in loans was in the real estate portfoliowhich increased $21.2 million (29.2%) while commercial loans increased $5.3million (10.0%). During 2008, the Company continued its efforts to originatereal estate loans where the Company has tangible collateral securing the loans.Real estate retains a value even in down markets unlike other collateral, suchas accounts receivable and business assets, which are more susceptible tosignificant declines in value. The real estate portfolio is largely composed ofloans secured by commercial real estate. The Company has little in acquisitionand development loans secured by residential building lots (approximately $2.5million). The Company’s residential loans consist of loans to investors inresidential property for rental, and are primarily secured by one to fourfamily properties.

 

The loan portfolio is thelargest component of earning assets and accounts for the greatest portion oftotal interest income. At December 31, 2008, gross loans were $153.0million, a 21.1% increase from the $126.3 million in gross loans outstanding atDecember 31, 2007.  Loans consist ofinternally generated loans and participation loans purchased from other localcommunity banks.  Lending activity isconfined to the Bank’s market area. The strong growth is attributable to thesatisfactory culmination of efforts to attract quality credits; there has beenno dilution of credit underwriting standards. The Bank does not engage inforeign lending activities.

 

The following table sets forth information on thecomposition of the loan portfolio by type:

 
| ** **                       | ** ** | **December 31, 2008** | ** ** | **December 31, 2007** | ** ** |
|----------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                       | ** ** | ** **                      | ** ** | **Percentage**                  | ** ** | ** ** | ** ** | **Percentage** | ** ** |
| **(In thousands)**          | ** ** | **Balance**                     | ** ** | **of Loans**               | ** ** | **Balance** | ** ** | **of Loans** | ** ** |
| Commercial and  industrial loans |       | $                               | 58,783     |                            | 38.4       | % | $ | 53,437 |   | 42.3 | % |
| Real estate  loans secured by:   |       |                            |       |                            |       |   |   |   |   |
| Residential real  estate         |       | 19,007                          |       | 12.4                            | %          | 12,100 |   | 9.6 | % |
| Commercial real  estate          |       | 75,200                          |       | 49.2                            | %          | 60,833 |   | 48.1 | % |
| Total real  estate loans         |       | 94,207                          |       | 61.6                            | %          | 72,933 |   | 57.7 | % |
|                             |       | 152,990                         |       | 100.0                           | %          | 126,370 |   | 100.0 | % |
| Unearned loan  fees, net         |       | (29                             | )          |                            |       | (35 | ) |   |   |
| Allowance for  loan losses       |       | (1,860                          | )          |                            |       | (1,665 | ) |   |   |
|                             |       | $                               | 151,101    |                            |       |   | $ | 124,670 |   |   |   |

 

The table belowsets forth the maturity distributions of the loan receivable portfolio as of December 31,2008. The table does not reflect loan re-pricing dates.

 

**LOAN MATURITIES AS OF DECEMBER 31, 2008**

 
| ** **                             | ** ** | **1 year**  | ** ** | ** **         | ** ** | **After**        | ** ** | ** ** | ** ** |
|----------------------------------------|------------|------------------|------------|--------------------|------------|------------------|------------|------------|------------|
| **(In thousands)**                | ** ** | **or less** | ** ** | **1-5 years** | ** ** | **5 years** | ** ** | **Total**  | ** ** |
| * *                               | ** ** | ** **       | ** ** | ** **         | ** ** | ** **       | ** ** | ** ** | ** ** |
| **Maturity of Loans Receivable:**      |       |             |       |               |       |             |       |       |       |
| Commercial loans                       |       | $                | 39,747     |               | $          | 10,389           |       | $          | 8,647      |   | $ | 58,783 |   |
| Real estate loans                      |       | 16,599           |       | 14,805             |       | 62,803           |       | 94,207     |       |
| Total loans receivable                 |       | $                | 56,346     |               | $          | 25,194           |       | $          | 71,450     |   | $ | 152,990 |   |
|                                   |       |             |       |               |       |             |       |       |       |
| Fixed interest rates                   |       | $                | 9,367      |               | $          | 20,348           |       | $          | 7,410      |   | $ | 37,125 |   |
| Floating and adjustable interest rates |       | 46,979           |       | 4,846              |       | 64,040           |       | 115,865    |       |
| Total loans receivable                 |       | $                | 56,346     |               | $          | 25,192           |       | $          | 71,450     |   | $ | 152,990 |   |

 

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The allowance for loanlosses was $1.9 million (1.22% of loans) at December 31, 2008.  The allowance was $1.7 million (1.32% ofloans) at December 31, 2007.  At December 31,2008, non-accrual loans totaled $5.8 million as compared to $1.1 million at December 31,2007.  The increase is predominatelyattributable to several large real estate loans that were placed on non-accrualstatus in December 2008. These loans are well secured by the value of thereal estate collateral. Loans charged off in 2008 totaled $498 thousand ascompared to $72 thousand during 2007. Recoveries on charged off loans were $45thousand during 2008 and $78 thousand during 2007.

 

Of the balance in theallowance account, “specific” reserves were $1.06 million and “general”reserves were $800 thousand. Specific reserves are used to individuallyallocate an allowance for loans identified as impaired, or which otherwiseexhibit adverse characteristics that suggest a heightened risk ofnon-collection.  General reserves arethose made with respect to unclassified loans in our portfolio based upon themethodology discussed below in order to maintain the allowance at a level whichreflects our best estimate of the losses inherent in the portfolio with respectto such loans.  Whether specific or general,amounts in the allowance for credit losses are available to absorb losses withrespect to any loan. At December 31, 2007, the allowance for credit lossesstood at $1.7 million, or 1.32% of outstanding gross loans. Of this amount, “specific”reserves were $693 thousand and “general” reserves were $972 thousand.

 

The allowance for loanlosses is determined based upon various loss ratios applied to categories ofloans except for loans rated substandard, doubtful or loss, which are evaluatedseparately and assigned specific reserve amounts, if necessary, based upon theevaluation.  Loss ratios are applied toeach category of loan to determine estimated loss amounts.  Categories of loans are identified ascommercial term or revolving loans, SBA loans, and closed and open ended realestate loans.  Additional loss ratios arealso applied for risks factors identified beyond individual loan risks, such aseconomic conditions, underwriting exceptions and loan concentrations based uponmanagement’s estimations of loss exposure. Loss ratios are determined based upon the Bank’s loan loss historyadjusted for estimated losses for the effect of current economic conditions(currently stressed), any industry concentration or identified weakness in anindustry, and credit management and underwriting policies changes, if any.

 

At December 31,2008, the range of the loss ratios used to determine estimated losses by loancategory were: commercial loans - 0.50%; SBA loans – 6%; and mortgage loans -0.15% to .95%.  Additional losses areestimated resulting from additional identified risks factors, such as loanswith underwriting exceptions, the level and direction of payment delinquenciesand the level of unsecured credit.  Theseadditional loss estimates are not allocated to the separate loan categories.

 

The computed allowancefor loan losses is tested through the use of the Bank’s loan risk ratingprocess. Loans are assigned a risk rating at their origination based uponrating criteria consistent with regulatory definitions.  The risk ratings are adjusted, as necessary,if loans become delinquent, if significant adverse information is discoveredregarding the underlying credit and, in the case of commercial loans andcommercial real estate loans, the normal periodic review (usually annually) ofthe underlying credit indicate that a change in risk rating isappropriate.  An estimated “low” and “high”loss percentage is applied to loans in each risk rating.  These loss percentages increase as the loanrisk rating increases.  Estimated lossesand reserves for loans rated as substandard, doubtful or loss are derived fromthe determination of the allowance for loan losses as discussed above as wellas estimated losses resulting from risk factors identified beyond individualloan risks, such as economic conditions, underwriting exceptions and loanconcentrations.  Loss percentages usedare generally based upon management’s best estimates considering lossesincurred.  Estimated “low” and “high”allowance for loan loss amounts are derived by accumulating the estimatedlosses using the “low” and “high” loss percentages for each risk rating andadding losses based upon separate loan evaluations and identified otherrisks.  The actual allowance for loanlosses is compared to this range to ascertain that it is situated within therange. At December 31, 2008, the “low” and “high” allowance determinationresulted in a “low” allowance of 1.20% of loans and a “high” allowance of 1.45%of loans.  The actual allowance for loanlosses was 1.22% of loans.

 

During 2008, there wereno significant changes in estimation methods or assumptions that affected themethodology for assessing the appropriateness of the allowance. In addition, onat least a quarterly basis, the recorded allowance for loan losses (as apercent of loans) is compared to peer group levels to ascertain thereasonableness of the estimate.

 

The allowance for loanlosses is 1.22% of outstanding loans at December 31, 2008 as compared to1.32% of loans at December 31, 2007. The reduction of the allowance as apercentage of loans is attributable to:

 

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(1)          Theincrease in outstanding loans during 2008 of $26.4 million included an increasein loans secured by real estate of $21.2 million (80.0% of the increase). Realestate loans generally provide significant collateral values to reduce lossesthus allowing for lower loss estimates and provisions. The Bank has notincurred a loss on a real estate loan since its inception although a specific lossreserve of $58 thousand has been established for one real estate loan at December 31,2008.

(2)          Constructionloans comprise less than 2% of total loans.

(3)          The Bankdoes not make consumer loans and has no home mortgage loans, unsecured consumerloans or home equity loans.

(4)          Loansoutstanding at December 31, 2008 in the amount of $39.1 million (25.6% ofthe total loans outstanding) were originated during 2008. These loans wereunderwritten during the un-settled economic environment that was prevalentduring 2008, with current real estate appraisals used for real estate loans.The Bank avoided lending to businesses significantly susceptible to worseningeconomic conditions.

(5)          The Bank’snet charge-offs (recoveries) as a percent of average loans outstanding since2004 were: 2004 - .10%, 2005 – (.16%), 2006 - .26%, 2007 – (.01%) and 2008 -..33%. The majority of the gross losses in 2007 and 2008 were losses on theuninsured portion of SBA loans which are decreasing as a percent of the loansoutstanding.

(6)          Themajority of the loans on non-accrual are real estate loans which are adequatelysecured with loan-to-value ratios of less than 70% based upon recentappraisals/valuations.

 

Based on the abovefactors including current economic conditions, management believes that theallowance for loan losses is adequate of December 31, 2008.

 

The activity in theallowance for credit losses is shown in the following table. All charge-offsand recoveries relate to commercial loans.

 

| ** **                                    | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------|------------|--------------------------------------------|------------|
| **(In thousands)**                       | ** ** | **2008**                                   | ** ** | **2007** | ** ** |
| Allowance for loan losses:                    |       |                                       |       |   |   |
| Beginning balance                             |       | $                                          | 1,665      |   | $ | 1,614 |   |
| Charge-offs- commercial loans                 |       | (497                                       | )          | (72 | ) |
| Recoveries- commercial loans                  |       | 45                                         |       | 78 |   |
| Net recoveries (charge-offs)                  |       | (452                                       | )          | 6 |   |
| Provision for loan losses                     |       | 647                                        |       | 45 |   |
| Ending balance                                |       | $                                          | 1,860      |   | $ | 1,665 |   |
|                                          |       |                                       |       |   |   |
| Net recoveries (charge-offs) to average loans |       | (0.33                                      | )%         | 0.01 | % |

 

During 2008 sixcommercial loans totaling $497 thousand, of which $319 thousand were theuninsured portion of SBA loans, were determined to be uncollectible andcharged-off. During 2007, four commercial loans totaling $72 thousand weredetermined to be uncollectible and were charged off. Recoveries of $45 thousand(three SBA loans) and $78 thousand (one non-SBA loan) previously charged-offwere realized during 2008 and 2007, respectively.

 

**Loan Quality**

 

In its lendingactivities, the Bank seeks to develop sound credits with customers who willgrow with the Bank. There has not been an effort to rapidly build the portfolioand earnings at the expense of asset quality. At the same time, the extension of credit inevitably carries some riskof non-payment.

 

Loanson which the accrual of interest has been discontinued amounted to $5.8million and $1.1 million at December 31,2008 and 2007, respectively.  Interest that would have been accrued underthe terms of these loans totaled $340 thousand and $78 thousand for the years ended December 31,2008 and 2007, respectively.  The Bank has no commitments to loanadditional funds to the borrowers of impaired or non-accrual loans.  The accrual of interest on loans isdiscontinued when a scheduled loan payment has become over ninety days pastdue.

 

5

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Non-accrual loan activityis summarized as follows since December 31, 2007:

 

| **(In thousands)**                 | ** ** | **LOAN AMOUNT** | ** ** |
|-----------------------------------------|------------|----------------------|------------|
|                                    |       |                 |       |
| Balance at  December 31, 2007      |       | $                    | 1,125      |   |
| New loans placed  on non-accrual        |       | 5,046                |       |
| Less:                                   |       |                 |       |
| Payments on  loans applied to principal |       | 116                  |       |
| Charge offs                             |       | 236                  |       |
| Balance at  December 31, 2008      |       | $                    | 5,819      |   |

 

Includedin the amount of non-accrual loans at December 31, 2008 are loans to threeborrowers totaling $3.6 million which are secured by real estate and one realestate loan in the amount of $788 thousand for which a specific reserve of $58thousand has been established.

 

Informationregarding loans classified as impaired follows:

 

| **(In thousands)**                                 | ** ** | **2008** | ** ** | **2007** | ** ** |
|---------------------------------------------------------|------------|----------|------------|----------|------------|
| Loans classified  as impaired with specific reserves    |       | $        | 1,892      |     | $          | 1,366 |   |
| Loans classified  as impaired with no specific reserves |       | $        | 3,927      |     | —     |   |
| Allowance for  loan losses on impaired loans            |       | 840      |       | 693      |       |
| Average balance  of impaired loans during year          |       | 2,142    |       | 740      |       |
|                                                         |            |          |            |          |            |  |  |

 

The classified loans withestablished specific reserves at December 31, 2008 include a non-accrualloan in the amount of $483 thousand ($583 thousand at December 31, 2007)which is the remaining balance of a relationship totaling $958 thousandclassified prior to 2006 and placed in non-accrual status at that time. Thisloan is secured by an assignment of life insurance proceeds.  The specific reserve allocated to this loanis $327 thousand. Also included is a loan secured by commercial real estate in the amount of $788 thousand for which aspecific reserve of $58 thousand has been established. Two loans to oneborrower totaling $263 thousand have specific reserves established at the loanamounts. The remaining balance of classified loans for which specific reservesat December 31, 2008 have been established is comprised of seven loans tofive borrowers in various stages of collection.

 

The classified loans forwhich no specific reserve has been established include three loans well securedby commercial real estate in the amount of $3.6 million. The remaining balance of classified loans forwhich no specific reserves have been established at December 31, 2008 iscomprised of four loans in various stages of collection.

 

TheBank has no loans past due over ninety days and still accruing interest and noreal estate owned at December 31, 2008 or 2007.  The Bank has restructured the scheduledpayment amounts from the original notes on two loans totaling less than $300thousand at December 31, 2008 (none at December 31, 2007). Specific reserves have been established forthese loans at amounts equal to the loan balances.

 

No interest was actuallyincluded in net income in respect of such loans after they were placed onnon-accrual status.  The accrual ofinterest on loans is discontinued when, in management’s opinion, the fullcollection of principal or interest is in doubt, or a scheduled loan payment hasbecome over ninety days past due.

 

At December 31, 2007, the Bank had nineloans totaling $1.1 million in non-accrual status:

 

·                  One loan in the amount of $583thousand is the remaining balance of a relationship totaling $958 thousand

 

6

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recognized as impaired inSeptember 2004 and placed in non-accrual status at that time. The specificreserve amount allocated to this loan was $426 thousand.

 

·                  The second loan in the amount of $175thousand was a delinquent loan partially secured by residential real estateowned by the guarantors of the loan. The Bank has a first lien on the residentialproperty in the amount of $100 thousand but is a third lien position as to theremaining portion of the loan. Collection proceedings had started and the Bankhad established specific reserves of $44 thousand for the loan.

 

·                  The remaining seven loans innon-accrual status totaled $367 thousand; the balance of each of the loans wasless than $100 thousand. These loans are partially secured by business andother assets of the borrower and/or guarantors. Specific reserves totaling $224thousand had been established for these loans which are in various stages ofcollection.

 

Management has notidentified any other loans which it has serious doubts as to the ability of theborrower to comply with the present repayment terms.

 

The following table showsthe allocation of the allowance for credit losses at the dates indicated.  The allocation of portions of the allowanceto specific categories of loans is not intended to be indicative of futurelosses, and does not restrict the use of the allowance to absorb losses in anycategory of loans.

 

**ALLOWANCE FOR LOAN LOSSES BYCATEGORY**

 

| ** **                      | ** ** | **December 31, 2008**  | ** ** | **December 31, 2007**                                                            | ** ** |
|---------------------------------|------------|----------------------------------|------------|--------------------------------------------------------------------------------------------|------------|
| **(In thousands)**              | ** ** | **Allocated  Allowance  Amount** | ** ** | **% of Loans in  each Category to  Total Loans  Receivable** | ** ** | **Allocated  Allowance  Amount** | ** ** | **% of Loans in  each Category to  Total Loans  Receivable** | ** ** |
| * *                        |       |                             |       |                                                                                       |       |   |   |   |   |
| Commercial and industrial loans |       | 1,538                            |       | 38.4                                                                                       | %          | $ | 1,284 |   | 42.3 | % |
| Real estate loans               |       | 317                              |       | 61.6                                                                                       | %          | 273 |   | 57.7 | % |
| Unallocated to loan type        |       | 5                                |       | —                                                                                     |       | 108 |   | — |   |
|                            |       | $                                | 1,860      |                                                                                       | 100.0      | % | $ | 1,665 |   | 100.0 | % |
|                                 |            |                                  |            |                                                                                            |            |  |  |  |  |  |  |

 

**Investments**

 

The investment securitiesportfolio at December 31, 2008 amounted to $3.1 million, a decrease of$6.1 million (66.3%) from the amount at December 31, 2007. Funds obtainedfrom the sale of securities and securities repayments were invested in loans during2008.  All of the investments securitiesare classified as “available for sale” and are reflected in the statement offinancial condition at their fair value. The carrying value of the securitiesincludes net unrealized gains of $77 thousand at December 31, 2008 and netunrealized gains of $142 thousand at December 31, 2007. These netunrealized gains and losses are reflected in stockholders equity, net ofdeferred taxes. Unrealized gains and losses are the result of interest ratelevels differing from those existing at the time of the acquisition of thesecurities. These unrealized gains and losses are considered temporary as theyreflect fair values on December 31, 2008 and 2007 and are subject tochange daily as interest rates fluctuate. The Company has the intent and theability to hold the securities to the maturity of the securities or the timerequired for the value of the securities to equal or exceed their cost.

 

The table below presentsthe composition and carrying amounts of securities in the investment securitiesportfolio, all of which are classified as available-for-sale and thus recordedat fair value, and investments in restricted stock, recorded at cost, as of December 31,2008 and 2007.

 

7

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| ** **              | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|-------------------------|------------|-----------------------|------------|-----------------------|------------|
| **(In thousands)** | ** ** | **2008**              | ** ** | **2007**              | ** ** |
| * *                | * *   | * *              | * *   | * *              | * *   |
| Investment securities:  |       |                  |       |                  |       |
| U.S Treasuries          |       | $                     | 3,086      |                  | $          | 9,168 |   |
| Restricted stock:       |       |                  |       |                  |       |
| Federal reserve stock   |       | 405                   |       | 405                   |       |
| Corporate equities      |       | 62                    |       | 62                    |       |
| Total securities        |       | $                     | 3,553      |                  | $          | 9,635 |   |

 

The tables below show thematurities and average weighted yields for the securities portfolio at December 31,2008.

 
| ** **              | ** ** | **Within one year** | ** ** | **After one but within  five years** | ** ** | **No Maturity** | ** ** |
|-------------------------|------------|-------------------------------|------------|----------------------------------------------------------|------------|----------------------|------------|
| **(In thousands)** | ** ** | **Amount**                    | ** ** | **Yield**                                                | ** ** | **Amount**           | ** ** | **Yield** | ** ** | **Amount** | ** ** | **Yield** | ** ** |
|                    |       |                          |       |                                                     |       |                 |       |   |   |   |   |   |   |
| Amortized cost basis:   |       |                          |       |                                                     |       |                 |       |   |   |   |   |   |   |
| U.S. Treasuries         |       | $                             | 3,009      |                                                     | 4.55       | %                    | —     |   | — |   | $ | — |   |   |   |
| Restricted stock        |       | —                        |       | —                                                   |       | —               |       | — |   | 467 |   | 5.39 | % |
| Total securities        |       | $                             | 3,005      |                                                     | 4.45       | %                    | —     |   | — |   | $ | 467 |   | 5.39 | % |
|                    |       |                          |       |                                                     |       |                 |       |   |   |   |   |   |   |
| Carrying Value:         |       |                          |       |                                                     |       |                 |       |   |   |   |   |   |   |
| U.S. Treasuries         |       | $                             | 3,086      |                                                     |       |                 | —     |   |   |   | $ | — |   |   |   |
| Restricted stock        |       | —                        |       |                                                     |       | —               |       |   |   | 467 |   |   |   |
| Total securities        |       | $                             | 3,086      |                                                     |       |                 | —     |   |   |   | $ | 467 |   |   |   |

 

AtDecember 31, 2008 and 2007, there were no issuers, other than the U.S.Government, whose securities owned by the Company have a book or market valueexceeding ten percent of the Company’s stockholders’ equity.

 

**Depositsand Liquidity Management**

** **

Deposits are themajor source of funds for lending and investment activities. At December 31,2008, deposits totaled $145.2 million as compared to $123.4 million at December 31,2007. Most of the $21.8 million increase is attributable to the increase incertificates of deposit during 2008. There were $50.1 million and $22.5 millionof brokered certificates of deposit at December 31, 2008 and 2007,respectively. Included in these brokered deposits are $16.0 million ofcertificates of deposits received in exchange for the placement of the Bank’scustomers’ deposit funds with other financial institutions under theCertificate of Deposit Account Registry Service (CDARS) program. Included indeposits are deposits of officers and directors (and their affiliatedentities), including CDARS program deposits, of $16.0 million.

 

Liquidity is a measure ofthe Company’s ability to meet the demands required for the funding of loans andto meet depositors’ requirements for use of their funds. The Company’sprincipal sources of liquidity are cash balances, due from banks, Federal fundssold and available-for-sale securities not pledged to the securities sold underagreement to repurchase program.

 

At December 31,2008, management considers the Company’s liquidity position to be satisfactory.At December 31, 2008, the Company’s principal sources of liquidity, asdefined, approximated $12.1 million and represented 7.2% of total Companyassets. Continued strong growth in deposits will be required to fund loangrowth. Accordingly, the Company intends to maintain a competitive posture inits deposit interest rate offerings. While adequate liquidity is imperative,excess liquidity has the effect of a lower interest margin, as funds notinvested in loans are placed in short-term investments that generally carry alower yield.

 

8

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The Company’sprincipal sources of funds are deposits, consisting of demand deposits, NOWaccounts, money market accounts, savings accounts and certificates ofdeposit.  These accounts provide theCompany with a relatively stable source of funds. We generally target largerdeposit relationships by offering competitive interest rates on certificates ofdeposit of $100,000 or more in our local markets. We supplement our localdeposits with out-of-area deposits obtained through the use of brokers,including the CDARS program. As a result, a substantial portion of ourdeposits, 57.3% at December 31, 2008, are comprised of deposit accounts of$100 thousand or more. The bank’s use of larger denomination certificates ofdeposit and brokered deposits facilitates funding the rapid growth in the loanportfolio. The Bank has used such certificates of deposits as a funding sourcesince its inception. While sometimes requiring higher interest rates, suchfunds carry lower acquisition costs (marketing, overhead costs) and can beobtained when required at the maturity dates desired. Most of the deposits over$100 thousand are fully insured by the FDIC through differing ownership andtrustee arrangements. All of the brokered deposits are fully insured by theFDIC. This insurance and the strong capital position of the Bank reduce thelikelihood of large deposit withdrawals for reasons other than interest ratecompetition. Interest rates on these deposits can be higher than other depositsproducts. There is, however, a risk that some deposits would be lost if rateswere to increase and the Bank elected not to remain competitive with its owndeposit rates. Under those conditions, the Bank believes that it is positionedto use other sources of funds, such as borrowing on its unsecured creditfacilities with other banks or the sale of investment securities or borrowingusing the securities as collateral, to offset a decline in deposits in theshort run.

 

The Bank has receivedapproval of unsecured credit facilities for short-term liquidity needs fromfinancial   institutions of $8,500,000 at December 31, 2008 and2007.  There were no borrowingsoutstanding under these credit arrangements at December 31, 2008 and 2007.

 

TheCompany believes its levels of liquidity are adequate to conduct the businessof the Company and Bank.

 

Interest bearing depositsare summarized below as of December 31:

 

| **(In thousands)**            | ** ** | **2008** | ** ** | **2007** | ** ** |
|------------------------------------|------------|----------|------------|----------|------------|
|                               |       |     |       |     |       |
| NOW accounts                       |       | $        | 1,247      |     | $          | 2,440 |   |
| Money Market  accounts             |       | 13,049   |       | 16,268   |       |
| Savings accounts                   |       | 148      |       | 36       |       |
| Certificates of  deposit accounts: |       |     |       |     |       |
| Less than  $100,000                |       | 37,539   |       | 11,383   |       |
| $100,000 or more                   |       | 69,659   |       | 74,035   |       |
|                               |       | $        | 121,642    |     | $          | 104,162 |   |

 

The time deposit accountsmature and/or re-price as follows (in thousands): within one year $84,586; onethrough three years- $21,629; three years and beyond- $983.

 

The table below shows thematurities and amounts of time certificates in amounts of $100,000 or more at December 31,2008 and 2007.

 

| ** **                             | ** ** | **December 31,** | ** ** |
|----------------------------------------|------------|-----------------------|------------|
| **(In thousands)**                     | ** ** | **2008**              | ** ** | **2007** | ** ** |
| * *                               |       |                  |       |   |   |
| Three months or less                   |       | $                     | 12,084     |   | $ | 11,933 |   |
| Over three but within twelve months    |       | 44,437                |       | 20,686 |   |
| Over twelve months through three years |       | 12,861                |       | 41,416 |   |
| Over three years                       |       | 277                   |       | — |   |
| Total                                  |       | $                     | 69,659     |   | $ | 74,035 |   |

 

9

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**Borrowedfunds**

 

The Bank entered intosales of securities under agreements to repurchase the same securities, whichmatured the next business day, with several commercial customers. This programwas discontinued in December 2008 because of the low interest rateenvironment significantly reduced the program’s value to the Bank and itscustomers. Furthermore, the expansion of FDIC insurance to all amounts innon-interest bearing accounts replaced the customers’ need for collateral tosupport their funds in the Bank.

 

Information concerningsecurities sold under agreements to repurchase at and during the year ended December 31,2008 and 2007 is summarized as follows:

 

| ** **                             | ** ** | **2008** | ** ** | **2007** | ** ** |
|----------------------------------------|------------|----------|------------|----------|------------|
| Total  outstanding at year-end         |       | $        | —     |     | $          | 4,305,936 |   |
| Average rate at  year end              | * *   | *—* | * *   | *2.40*   | *%*        |
| Average balance  during the year       |       | $        | 2,650,978  |     | $          | 3,494,779 |   |
| Average interest  rate during the year | * *   | *1.12*   | *%*        | *2.62*   | *%*        |
| Maximum amount  at any month end       |       | $        | 5,494,595  |     | $          | 9,492,000 |   |

 

10

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**Stockholders’ Equity**

 

Total stockholders’equity was $20.3 million at December 31, 2008 representing an increase of$254 thousand from December 31, 2007. The increase from December 31, 2007 was attributable to the netincome of the Company of $295 thousand less a reduction of other comprehensiveincome of $41 thousand.

 

At December 31,2008, we continued to exceed all regulatory capital requirements to beconsidered a “well capitalized” financial institution under federalregulations. The Company believes its level capital is adequate to conduct thebusiness of the Company and Bank.

 

**RESULTS OF OPERATIONS**

 

Net income for the yearended December 31, 2008 was $295 thousand ($0.16 basic and dilutedearnings per share), a decrease of $793 thousand, or 72.9%, from the net incomeof $1.1 million ($0.60 basic earnings per share; $0.59 diluted earnings pershare) during 2007.  Net income decreasedin 2008 as compared to 2007 primarily because of the decline in net interest incomeof $328 thousand, increased provision for loan losses of $602 thousand andincreased non-interest expenses of $340 thousand (all amounts are before taxeffects).

 

Return on equity, returnon assets and ratio of equity to assets are as follows:

 

**RETURN ONAVERAGE ASSETS AND AVERAGE EQUITY**

**YearEnded December 31,**

 
| ** **                                 | ** ** | **2008** | ** ** | **2007** | ** ** |
|--------------------------------------------|------------|----------|------------|----------|------------|
|                                       |       |     |       |     |       |
| Return on  Average Equity                  |       | 1.92     | %          | 7.47     | %          |
|                                       |       |     |       |     |       |
| Return on  Average Earning Assets          |       | 0.25     | %          | 1.07     | %          |
|                                       |       |     |       |     |       |
| Ratio of Average  Equity to Average Assets |       | 12.86    | %          | 13.93    | %          |

 

**NetInterest Income and Net Interest Margin**

 

Net interest income isthe difference between income on assets and the cost of funds supporting thoseassets. Earning assets are composed primarily of loans and investments; theexpense associated with interest bearing deposits and customer repurchaseagreements and other borrowings is the cost of funds. Non-interest bearingdeposits and capital are other components representing funding sources. Changesin the volume and mix of assets and funding sources, along with the changes inyields earned and rates paid, determine changes in net interest income.

 

Total interest incomedecreased by $110 thousand or 1.0% to $10.7 million for the year ended December 31,2008 as compared to 2007.  This decreasewas primarily attributable to the rapid and deep reduction of market interestrates as directed by the Federal Reserve in response to severe liquidity andasset quality issues experienced by the financial industry during 2008. Thedecrease in interest rates, from a federal funds target rate of 4.25% at December 31,2007 to 0.25% at December 31, 2008, offset the effect of the increase inloans outstanding during the year of 2008 as compared to 2007. Average interestearning assets increased by $18.9 million during 2008 as compared to 2007;however, the yield on earning assets decreased to 6.86% in 2008 from 7.96% in2007.

 

Interest expenseincreased by $0.2 million or 4.5% to $5.1 million for the year ended December 31,2008 as compared $4.9 million in 2007. This increase was attributable to the increase in average interestbearing liabilities of $19.0 million (19.0%). The effect from increased volumeof interest bearing liabilities was offset somewhat by the decrease in the costof funds to 4.26% in 2008 from 4.86% in 2007. The cost of funds did not declineas rapidly as the reduction in market interest rates during 2008 since a largeportion of the Bank’s deposits are in the form of certificates of depositswhich have fixed interest rates and scheduled maturity dates. Although theCompany currently expects rates on certificates of deposit to decline as suchdeposits mature and re-price as a result of competitive pressures, customerpreferences and future changes in interest rates, there can be no assurancethat the Company will achieve declines in its cost of funds, or that suchdeclines will improve the Company’s margin or net income.

 

11

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Net interest income was$5.6 million in 2008, a $328 thousand decrease from the $5.9 million netinterest income in 2007, a 5.6% decline. The decrease in net interest incomeresults primarily from the earning assets re-pricing faster than the re-pricingof the interest bearing liabilities during the period of rapidly declininginterest rates during 2008.

 

The following table providesinformation for the designated periods with respect to average balances, incomeand expense and annualized yields and costs associated with various categoriesof interest earning assets and interest bearing liabilities for the past threeyears. Non-accrual loans have been included in the preparation of the table.The table includes a measurement of spread and margin. Interest spread is themathematical difference between the average interest yield on interest earningassets and average interest paid on interest bearing liabilities. Interestmargin is the net interest yield on interest earning assets and is derived bydividing net interest income by average interest earning assets.

 

**AVERAGE BALANCES, RATES ANDINTEREST INCOME AND EXPENSE**

**Years Ended**

 
| ** **                                     | ** ** | **2008**    | ** ** | **2007**     | ** ** |
|------------------------------------------------|------------|-------------|------------|--------------|------------|
| ** **                                     | ** ** | **Average** | ** ** | ** **   | ** ** | **Yield/** | ** ** | **Average** | ** ** | ** ** | ** ** | **Yield/** | ** ** |
| **(In thousands)**                        | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** |
| **Assets:**                                    |       |        |       |         |       |   |   |   |   |   |   |   |   |
| Interest Earning Assets:                       |       |        |       |         |       |   |   |   |   |   |   |   |   |
| Loans receivable                               |       | $           | 138,166    |         | $          | 10,130 |   | 7.31 | % | $ | 111,385 |   | $ | 9,680 |   | 8.69 | % |
| Investment securities                          |       | 7,718       |       | 341          |       | 4.41 | % | 10,750 |   | 460 |   | 4.28 | % |
| Interest bearing deposits                      |       | 306         |       | 8            |       | 2.61 | % | — |   | — |   | — |   |
| Federal funds sold                             |       | 8,654       |       | 171          |       | 1.97 | % | 13,810 |   | 683 |   | 4.95 | % |
|                                           |       |        |       |         |       |   |   |   |   |   |   |   |   |
| Total Interest Earning Assets                  |       | 154,844     |       | 10,650       |       | 6.86 | % | 135,945 |   | 10,823 |   | 7.96 | % |
|                                           |       |        |       |         |       |   |   |   |   |   |   |   |   |
| Less allowance for loan losses                 |       | (1,738      | )          |         |       |   |   | (1,705 | ) |   |   |   |   |
| Non-Interest Earning Assets                    |       | 5,971       |       |         |       |   |   | 5,236 |   |   |   |   |   |
| Total Assets                                   |       | $           | 159,077    |         |       |   |   |   | $ | 139,476 |   |   |   |   |   |
| ** **                                     |       |        |       |         |       |   |   |   |   |   |   |   |   |
| **Liabilities and Stockholders’ Equity:** |       |        |       |         |       |   |   |   |   |   |   |   |   |
| Interest -Bearing Liabilities:                 |       |        |       |         |       |   |   |   |   |   |   |   |   |
| Interest bearing demand deposits               |       | $           | 1,373      |         | $          | 3 |   | 0.22 | % | $ | 2,333 |   | $ | 32 |   | 1.37 | % |
| Money market deposit accounts                  |       | 17,852      |       | 321          |       | 1.79 | % | 18,466 |   | 715 |   | 3.87 | % |
| Savings accounts                               |       | 91          |       | —       |       | — |   | 141 |   | 1 |   | 0.71 | % |
| Certificates of deposit                        |       | 97,124      |       | 4,729        |       | 4.86 | % | 75,651 |   | 4,027 |   | 5.32 | % |
| Securities sold under agreements to repurchase |       | 2,651       |       | 30           |       | 1.13 | % | 3,495 |   | 92 |   | 2.63 | % |
| Total Interest Bearing Liabilities             |       | 119,091     |       | 5,083        |       | 4.26 | % | 100,086 |   | 4,867 |   | 4.86 | % |
|                                           |       |        |       |         |       |   |   |   |   |   |   |   |   |
| Non-Interest Bearing Liabilities:              |       |        |       |         |       |   |   |   |   |   |   |   |   |
| Demand deposits                                |       | 18,608      |       |         |       |   |   | 18,884 |   |   |   |   |   |
| Other                                          |       | 917         |       |         |       |   |   | 1,075 |   |   |   |   |   |
| Total Liabilities                              |       | 138,616     |       |         |       |   |   | 120,045 |   |   |   |   |   |
| Stockholders’ Equity                      |       | 20,461      |       |         |       |   |   | 19,431 |   |   |   |   |   |
| Total Liabilities and Equity                   |       | $           | 159,077    |         |       |   |   |   | $ | 139,476 |   |   |   |   |   |
| Net Interest Income                            |       |        |       | $            | 5,567      |   |   |   |   |   | $ | 5,956 |   |   |   |
|                                           |       |        |       |         |       |   |   |   |   |   |   |   |   |
| Net Interest Spread                            |       |        |       |         |       | 2.60 | % |   |   |   |   | 3.10 | % |
| Net Interest Margin                            |       |        |       |         |       | 3.59 | % |   |   |   |   | 4.38 | % |

 

*Yields onsecurities are calculated based on amortized cost.*

 

The decrease in netinterest margin and net interest spread in 2008 as compared to 2007 resultsfrom the Bank’s assets re-pricing more rapidly than its deposits as a largeportion of the deposits are comprised of fixed rate certificates of deposit.

 

12

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**Rate/Volume Analysis of NetInterest Income**

 

The following table setsforth certain information regarding changes in interest income and interestexpense of the Company for the years indicated. For each category of interest-earning assets and interest-bearingliabilities, information is provided on changes attributable to: (i) changesin volume (change in volume of the asset multiplied by the prior year’s rate)and (ii) changes in rates (change in rate multiplied by the current year’svolume).

 

**RATE/VOLUME ANALYSIS**

 
| ** **                                     | ** ** | **2008 vs. 2007**  | ** ** | **2007 vs. 2006**  | ** ** |
|------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                     | ** ** | **Increase (Decrease)** | ** ** | **Increase (Decrease)** | ** ** |
| **In thousands)**                         | ** ** | **Volume**                   | ** ** | **Rate**                     | ** ** | **Total** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Total** | ** ** |
| **Interest-Earning Assets:**                   |       |                         |       |                         |       |   |   |   |   |   |   |   |   |
| Federal funds sold                             |       | $                            | (255       | )                            | $          | (257 | ) | $ | (512 | ) | $ | 213 |   | $ | (8 | ) | $ | 205 |   |
| Interest bearing deposits                      |       | 8                            |       | —                       |       | 8 |   | — |   | — |   | — |   |
| Investment portfolio                           |       | (130                         | )          | 12                           |       | (118 | ) | 102 |   | 82 |   | 184 |   |
| Loans receivable                               |       | 2,313                        |       | (1,802                       | )          | 511 |   | 2,056 |   | 172 |   | 2,228 |   |
| **Net Change in Interest Income**              |       | 1,936                        |       | (2,047                       | )          | (111 | ) | 2,371 |   | 246 |   | 2,617 |   |
|                                           |       |                         |       |                         |       |   |   |   |   |   |   |   |   |
| **Interest Bearing Liabilities:**              |       |                         |       |                         |       |   |   |   |   |   |   |   |   |
| Interest bearing deposits                      |       | 981                          |       | (703                         | )          | 278 |   | 1,199 |   | 802 |   | 2,001 |   |
| Other borrowed funds                           |       | —                       |       | —                       |       | — |   | (4 | ) | — |   | (4 | ) |
| Securities sold under agreements to repurchase |       | (22                          | )          | (40                          | )          | (62 | ) | (38 | ) | 2 |   | (36 | ) |
| **Net Change in Interest Expense**             |       | 959                          |       | (743                         | )          | 216 |   | 1,157 |   | 804 |   | 1,961 |   |
|                                           |       |                         |       |                         |       |   |   |   |   |   |   |   |   |
| **Change in Net Interest Income**              |       | $                            | 977        |                         | $          | (558 | ) | $ | (327 | ) | $ | 1,214 |   | $ | (558 | ) | $ | 656 |   |

 

**Provisionfor Loan Losses**

 

The provision for loanlosses represents the expense recognized to fund the allowance for loan losses.The loan loss expense of $647 thousand for the year ended December 31,2008 reflected an increase of $602 thousand from the provision of $45 thousandfor the year ended December 31, 2007. This increase is the result ofspecific valuation reserves on loans experiencing repayment problems and thelosses incurred during 2008, predominately in the Bank’s uninsured SBA loanportfolio which is most affected by the current reduced economic activityperiod. The SBA portfolio comprises 3.8% of total loans outstanding at December 31,2008, which percentage has declined since December 31, 2007. The allowancefor loan losses, and therefore the provision for loan losses, containsincreased amounts for the uninsured SBA portfolio.

 

Additionally, the Bankhas established a reserve for unfunded commitments that is recorded by aprovision charged to other expenses.  Thebalance of this reserve was $48 thousand and $42 thousand at December 31,2008 and 2007, respectively. The reserve is an amount that management believes willbe adequate over time to absorb possible losses on unfunded commitments(off-balance sheet financial instruments) that may become uncollectible in thefuture.

 

**Non-interestIncome**

 

Non-interest income principally consists of gains fromthe sale of the guaranteed portion of Small Business Administration loans, gainon sale of securities and deposit account services charges.

 

For the years ended December 31, 2008 and 2007,gains from the sales of SBA loans amounted to $241 thousand and $344 thousand,respectively. The guaranteed portion of most SBA loans is usually sold toothers resulting in gains on the sales. The volume of loan sales and resultantgains will vary depending of the volume of originations of loans with SBAguarantees and the pricing of the sales of the loans. Gain on sale ofsecurities was $40 thousand in 2008, none in 2007.

 

For the year ended December 31, 2008, depositaccount services charges amounted to $287 thousand as compared to $276 thousandfor the year ended December 31, 2007.

 

13

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##### **Non-interestExpense**

 

Non-interest expensetotaled $5.0 million for the year ended December 31, 2008 as compared to$4.7 million in 2007, a 7.3% increase. In each period, salary and benefitexpense was the largest component: $2.9 million and $2.6 million in 2008, 2007,respectively. The expense increase is attributable to normal salary increasesand several additional personnel needed to grow and manage the loan portfolio.Data processing, support services and depreciation and amortization expensesincreased primarily as the result of increased operational expenses related tothe new core processing system and internet banking platform that was installedin the second quarter of 2007. The conversion to the new systems and platformwas completed in 2007; therefore, there are no conversion expenses during 2008.

 

**IncomeTaxes**

 

The Company uses theliability method of accounting for income taxes as required by SFAS No.109,*Accounting for Income Taxes*.  Under the liability method, deferred taxassets and liabilities are determined based on differences between thefinancial statement carrying amounts and the enacted rates that will be ineffect when these differences reverse. Income tax expense for 2008 was $166 thousand (36.1% of pretax income)and $695 thousand (39.0% of pretax income) in 2007.

 

**Off-Balance Sheet Arrangements**

 

With the exception of theBank’s obligations in connection with its irrevocable letters of credit andloan commitments, the Bank has no off-balance sheet arrangements that have orare reasonably likely to have a current or future effect on the Bank’sfinancial condition, changes in financial condition, revenues or expenses,results of operations, liquidity, capital expenditures, or capital resources,that is material to investors. For additional information on off-balance sheetarrangements, please see the notes to the Consolidated Financial Statements.

 

**Interest Rate Risk Management**

 

Banks and other financialinstitutions are dependent upon net interest income, the difference betweeninterest earned on interest earning assets and interest paid on interestbearing liabilities. Changes in interest rates inevitably have an impact oninterest income. GAP, a measure of the difference in volume between interestbearing assets and interest bearing liabilities, is a means of monitoring thesensitivity of a financial institution to changes in interest rates. The chartbelow provides an indicator of the rate sensitivity of the Company.  A positive GAP indicates the degree to whichthe volume of repriceable assets exceeds repriceable liabilities in particulartime periods.  The Company has a positiveGAP, an asset sensitive position, during for a one year period which wouldgenerally indicate increased net interest income in a rising rate environmentand a decreased net interest income in a declining rate environment.  However, this measurement of interest raterisk sensitivity represents a static position as of a single day and is notnecessarily indicative of the interest rate risk position at any other point intime, does not take into account the sensitivity of yields and costs ofspecific assets and liabilities to changes in market rates, and does not takeinto account the specific timing of when changes to a specific asset orliability will occur. Further this measurement does not take into account theeffect of competitive factors on interest rates, and the effect of changes ininterest rates on the capacity of customers to meet their obligations. The Companywill be addressing the current positive GAP level for the purpose of reducingits exposure to interest rate changes, although there can be no assurance thatthe Company’s efforts will be successful in reducing its exposure to interestrate changes, or that it will correctly predict the timing and magnitude ofchanges in interest rate.

 

14

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**RATE SENSITIVITY ANALYSIS(Static GAP)**

 
| ** **                       | ** ** | ** ** | ** ** | **December 31, 2008** | ** ** | ** ** | ** ** | ** **     | ** ** |
|----------------------------------|------------|------------|------------|---------------------------------|------------|------------|------------|----------------|------------|
| ** **                       | ** ** | **0-3**    | ** ** | **4-12**                        | ** ** | **1-3**    | ** ** | **>3<5** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **(In thousands)**          | ** ** | **Months** | ** ** | **Months**                      | ** ** | **Years**  | ** ** | **Years**      | ** ** | **5 YRS +** | ** ** | **Total** | ** ** |
| ** **                       |       |       |       |                            |       |       |       |           |       |   |   |   |   |
| **Interest earning assets**      |       |       |       |                            |       |       |       |           |       |   |   |   |   |
| Federal funds sold               |       | $          | 5,674      |                            | $          | —     |       | $              | —     |   | $ | — |   | $ | — |   | $ | 5,674 |   |
| Securities, at cost              |       | —     |       | 3,009                           |       | —     |       | —         |       | — |   | 3,009 |   |
| Loans*                           |       | 50,284     |       | 11,552                          |       | 33,038     |       | 48,933         |       | 3,236 |   | 147,043 |   |
| Total                            |       | 55,958     |       | 14,561                          |       | 33,038     |       | 48,933         |       | 3,236 |   | 155,726 |   |
|                             |       |       |       |                            |       |       |       |           |       |   |   |   |   |
| **Interest bearing liabilities** |       |       |       |                            |       |       |       |           |       |   |   |   |   |
| Savings/Money Market/NOW         |       | 14,444     |       | —                          |       | —     |       | —         |       | — |   | 14,444 |   |
| Certificates of deposit          |       | 27,683     |       | 56,904                          |       | 21,628     |       | 983            |       | — |   | 107,198 |   |
| Total                            |       | 42,127     |       | 56,904                          |       | 21,628     |       | 983            |       | — |   | 121,642 |   |
| ** **                       |       |       |       |                            |       |       |       |           |       |   |   |   |   |
| **GAP:**                         |       |       |       |                            |       |       |       |           |       |   |   |   |   |
| Period                           |       | $          | 13,831     |                            | (42,343    | )          | 11,410     |           | 47,950     |   | 3,236 |   | $ | 34,084 |   |
| Cumulative                       |       |       |       | $                               | (28,512    | )          | $          | (17,102        | )          | $ | 30,848 |   | $ | 34,084 |   |   |   |   |

 

----

**Loan amounts above exclude loans on non-interest accrual of $5.8million and deferred fees of $29 thousand.*

 

**Capital Resources and Adequacy**

 

The assessment of capitaladequacy depends on a number of factors such as asset quality, liquidity,earnings performance, and changing competitive conditions and economicforces.  The adequacy of the Company’scapital is reviewed by management on an ongoing basis.  Management seeks to maintain a capitalstructure that will assure an adequate level of capital to support anticipatedasset growth and to absorb potential losses. The ability of the Company to grow is dependent on the availability ofcapital with which to meet regulatory capital requirements, discussedbelow.  To the extent the Company issuccessful it may need to acquire additional capital through the sale ofadditional common stock, other qualifying equity instruments, such as trustpreferred securities, or subordinated debt. There can be no assurance that additional capital will be available tothe Company on a timely basis or on attractive terms.

 

Under recent guidance bythe federal banking regulators, banks which have concentrations inconstruction, land development or commercial real estate loans (other thanloans for majority owner occupied properties) would be expected to maintainhigher levels of risk management and, potentially, higher levels ofcapital.  It is possible that we may berequired to maintain higher levels of capital than we would otherwise beexpected to maintain as a result of our levels of construction, development andcommercial real estate loans, which may require us to obtain additionalcapital.

 

The capital positions ofthe Company and the Bank continue to meet and exceed regulatory requirements.Details of these requirements are shown in the notes to the ConsolidatedFinancial Statements.

 

The Companyelected not to participate in the Capital Purchase Program (“CPP”) that wasavailable to eligible banks through November 14, 2008 under the TreasuryDepartment’s Troubled Asset Relief Program (“TARP”) concluding that there wasno financial or strategic advantage to be gained by participation in the TARP’sCapital Purchase Program. The Bank’s own capital levels exceed the guidelinesfor well-capitalized financial institutions. Additionally, the Company has$3,000,000 in readily available reserves that could be contributed to the Bankif needed. These cash reserves held by the Company approximate the funds thatwould have been available under the Capital Purchase Program. Accordingly, theCompany decided not to dilute the shares of its current stockholders inexchange for a TARP capital infusion. TheCompany does not have direct exposure to the subprime mortgage issues whichprecipitated the economic volatility and stress in that it did not makeresidential mortgage loans to retain customers, and did not invest in mortgageback securities or the preferred stock of Freddie Mac and Fannie Mae.Furthermore, the Company found it an unacceptable risk that the 

 

15

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Treasury reserved theright to unilaterally change the terms and conditions of the CPP based uponfuture changes in law, which could be politically motivated or based onoverbroad generalizations regarding the industry.

 

**Market for Common Stock and Dividends**

 

The Company’sCommon Stock is listed for trading on the NASDAQ Capital Market under thesymbol “CFMB.” The following table sets forth the high and low sales prices forthe Common Stock during each calendar quarter of 2008 and 2007. Thesequotations reflect inter-dealer prices, without retail markup, markdown orcommission, and may not represent actual transactions. These quotations do notnecessarily reflect the intrinsic or market values of the Common Stock.  As of December 31, 2008, there were1,820,548 shares of Common Stock outstanding, held by approximately 300shareholders of record.

 
| ** **     | ** ** | **2008** | ** ** | **2007** | ** ** |
|----------------|------------|----------|------------|----------|------------|
| ** **     | ** ** | **High** | ** ** | **Low**  | ** ** | **High** | ** ** | **Low** | ** ** |
| First Quarter  |       | $        | 11.30      |     | $          | 9.90 |   | $ | 14.25 |   | $ | 13.16 |   |
| Second Quarter |       | 10.75    |       | 8.32     |       | 16.00 |   | 13.38 |   |
| Third Quarter  |       | 8.82     |       | 7.09     |       | 13.75 |   | 12.50 |   |
| Fourth Quarter |       | 8.25     |       | 5.25     |       | 13.75 |   | 11.00 |   |
|                |            |          |            |          |            |  |  |  |  |  |  |  |  |

 

The Company hasnot paid dividends through December 31, 2008. The payment of dividends bythe Company will depend largely upon the ability of the Bank, its soleoperating business, to declare and pay dividends to the Company.  Regulations of the Federal Reserve Board andMaryland law place limits on the amount of dividends the Bank may pay to theCompany without prior approval.  Priorregulatory approval is required to pay dividends which exceed the Bank’s netprofits for the current year plus its retained net profits for the precedingtwo calendar years, less required transfers to surplus.  Additionally, without prior approval, theBank may pay dividends only out of its undivided profits. Even if the Bank andthe Company have earnings in an amount sufficient to pay dividends, the Boardof Directors may determine to retain earnings for the purpose of funding thegrowth of the Company and the Bank.

 

### **Financial Statements**

 

The auditedfinancial statements for the Company as of December 31, 2008 and 2007 andfor each of the years then ended are included herewith.

 

16

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**COMMERCEFIRSTBANCORP, INC. and SUBSIDIARY**

 

**CONSOLIDATEDFINANCIAL STATEMENTS**

 

##### **DECEMBER31, 2008**

 

1

----

 

[Letterhead of Trice Geary & Myers, LLC]

 

** **REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

TheBoard of Directors

CommerceFirstBancorp, Inc. and Subsidiary

Annapolis,Maryland

 

Wehave audited the accompanying consolidated statements of financial condition ofCommerceFirst Bancorp, Inc. and subsidiary as of December 31, 2008 and 2007, and the related consolidatedstatement of operations, comprehensive income, stockholders’ equity, and cashflows for each of the years in the two-year period ended December 31, 2008.  CommerceFirst Bancorp, Inc. andsubsidiary’s management is responsible for these consolidated financialstatements.  Our responsibility is toexpress an opinion on these consolidated financial statements based on ouraudits.

 

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the consolidatedfinancial statements are free of material misstatement.  The Company is not required to have, nor werewe engaged to perform, an audit of its internal control over financialreporting.  Our audit includedconsideration of internal control over financial reporting as a basis fordesigning audit procedures that are appropriate in the circumstances, but notfor the purpose of expressing an opinion on the effectiveness of the Company’sinternal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supportingthe amounts and disclosures in the consolidated financial statements, assessingthe accounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonablebasis for our opinion.

 

Inour opinion, the consolidated financial statements referred to above presentfairly, in all material respects, the consolidated financial position ofCommerceFirst Bancorp, Inc. and subsidiary as of December 31, 2008 and 2007, and the consolidated results oftheir operations and their consolidated cash flows for each of the years in thetwo-year period ended December 31,2008 in conformity with accounting principles generally accepted in theUnited States of America.

 
| /s/ Trice Geary & Myers LLC |   |
|--------------------------------------|--------|
|                                 |   |
| Salisbury,  Maryland                 |   |
| February 9, 2009                |   |

 

2

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**CommerceFirst Bancorp, Inc. and Subsidiary**

**ConsolidatedStatements of Financial Condition**

**December 31, 2008 and December 31, 2007**

 
| ** **                                                                                                                                                           | ** ** | **December 31,** | ** **  | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|-------------|-----------------------|------------|
| ** **                                                                                                                                                           | ** ** | **2008**              | ** **  | **2007**              | ** ** |
| **ASSETS**                                                                                                                                                           |       |                  |        |                  |       |
|                                                                                                                                                                 |       |                  |        |                  |       |
| Cash and due  from banks                                                                                                                                             |       | $                     | 3,290,691   |                  | $          | 3,001,573 |   |
| Federal funds  sold                                                                                                                                                  |       | 5,673,666             |        | 8,723,315             |       |
| Cash and cash  equivalents                                                                                                                                           |       | 8,964,357             |        | 11,724,888            |       |
| Investment  securities – available-for-sale, at fair value                                                                                                      |       | 3,085,770             |        | 9,167,700             |       |
| Investments in  restricted stocks, at cost                                                                                                                           |       | 467,000               |        | 467,000               |       |
| Loans  receivable, net of allowance for loan losses of $1,860,000 at  December 31, 2008 and $1,665,000 at December 31, 2007                                |       | 151,101,169           |        | 124,669,790           |       |
| Premises and  equipment, net                                                                                                                                         |       | 1,000,967             |        | 1,097,927             |       |
| Accrued interest  receivable                                                                                                                                         |       | 639,538               |        | 742,766               |       |
| Deferred income  taxes                                                                                                                                               |       | 667,993               |        | 551,882               |       |
| Other assets                                                                                                                                                         |       | 642,280               |        | 388,630               |       |
| Total Assets                                                                                                                                                         |       | $                     | 166,569,074 |                  | $          | 148,810,583 |   |
|                                                                                                                                                                 |       |                  |        |                  |       |
| **LIABILITIES**                                                                                                                                                      |       |                  |        |                  |       |
|                                                                                                                                                                 |       |                  |        |                  |       |
| Non-interest bearing  deposits                                                                                                                                       |       | $                     | 23,598,842  |                  | $          | 19,245,887 |   |
| Interest bearing  deposits                                                                                                                                           |       | 121,642,218           |        | 104,161,959           |       |
| Total deposits                                                                                                                                                       |       | 145,241,060           |        | 123,407,846           |       |
|                                                                                                                                                                 |       |                  |        |                  |       |
| Securities sold  under agreements to repurchase                                                                                                                      |       | —                |        | 4,305,936             |       |
| Accrued interest  payable                                                                                                                                            |       | 265,105               |        | 201,253               |       |
| Other  liabilities                                                                                                                                                   |       | 752,352               |        | 839,187               |       |
| Total  Liabilities                                                                                                                                                   |       | 146,258,517           |        | 128,754,222           |       |
|                                                                                                                                                                 |       |                  |        |                  |       |
| **STOCKHOLDERS’  EQUITY**                                                                                                                                       |       |                  |        |                  |       |
| Common stock -  $.01 par value; authorized 4,000,000 shares. Issued and outstanding:  1,820,548 shares at December 31, 2008 and at December 31, 2007  |       | 18,205           |        | 18,205           |       |
| Additional  paid-in capital                                                                                                                                          |       | 17,852,931            |        | 17,852,931            |       |
| Retained  earnings                                                                                                                                                   |       | 2,392,882             |        | 2,097,967             |       |
| Accumulated  other comprehensive income:                                                                                                                             |       |                  |        |                  |       |
| Net unrealized  gain on securities available-for-sale                                                                                                                |       | 46,539                |        | 87,258                |       |
| Total  Stockholders’ Equity                                                                                                                                     |       | 20,310,557            |        | 20,056,361            |       |
| Total  Liabilities and Stockholders’ Equity                                                                                                                     |       | $                     | 166,569,074 |                  | $          | 148,810,583 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

3

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**CommerceFirst Bancorp, Inc. and Subsidiary**

**Consolidated Statements of Operations**

**For the Years Ended December 31, 2008 and 2007**

 
| ** **                                           | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                           | ** ** | **2008**              | ** ** | **2007**              | ** ** |
| Interest income:                                     |       |                  |       |                  |       |
| Interest and  fees on loans                          |       | $                     | 10,129,748 |                  | $          | 9,618,831 |   |
| U.S. Treasury  securities                            |       | 316,944               |       | 434,685               |       |
| Investment in  stocks                                |       | 25,093                |       | 25,153                |       |
| Interest bearing  deposits                           |       | 7,960                 |       | —                |       |
| Federal funds  sold                                  |       | 171,009               |       | 682,783               |       |
| Total interest  income                               |       | 10,650,754            |       | 10,761,452            |       |
| Interest  expense:                                   |       |                  |       |                  |       |
| Deposits                                             |       | 5,053,614             |       | 4,775,274             |       |
| Repurchase  agreements                               |       | 29,852                |       | 91,605                |       |
| Total interest  expense                              |       | 5,083,466             |       | 4,866,879             |       |
|                                                 |       |                  |       |                  |       |
| Net interest  income                                 |       | 5,567,288             |       | 5,894,573             |       |
|                                                 |       |                  |       |                  |       |
| Provision for  loan losses                           |       | 647,105               |       | 45,383                |       |
| Net interest  income after provision for loan losses |       | 4,920,183             |       | 5,849,190             |       |
|                                                 |       |                  |       |                  |       |
| Non-interest  income:                                |       |                  |       |                  |       |
| Gain on sale of  SBA loans                           |       | 241,220               |       | 344,421               |       |
| Gain on sale of  securities                          |       | 40,431                |       | —                |       |
| Service charges  and other income                    |       | 287,417               |       | 276,433               |       |
| Total  non-interest income                           |       | 569,068               |       | 620,854               |       |
|                                                 |       |                  |       |                  |       |
| Non-interest  expenses:                              |       |                  |       |                  |       |
| Compensation and  benefits                           |       | 2,865,510             |       | 2,646,492             |       |
| Legal and  professional                              |       | 298,167               |       | 221,479               |       |
| Rent and  occupancy                                  |       | 536,940               |       | 500,911               |       |
| Marketing and business  development                  |       | 121,660               |       | 107,617               |       |
| Core processing  conversion                          |       | —                |       | 117,227               |       |
| Insurance                                            |       | 43,267                |       | 42,433                |       |
| Data processing                                      |       | 132,206               |       | 112,287               |       |
| Support services                                     |       | 179,586               |       | 132,546               |       |
| Communications                                       |       | 112,437               |       | 106,260               |       |
| Office supplies                                      |       | 59,625                |       | 101,406               |       |
| Depreciation and  amortization                       |       | 294,009               |       | 233,681               |       |
| Other                                                |       | 384,532               |       | 365,386               |       |
| Total  non-interest expenses                         |       | 5,027,939             |       | 4,687,725             |       |
| Income before  income taxes                          |       | 461,312               |       | 1,782,319             |       |
| Income tax  expense                                  |       | 166,397               |       | 694,505               |       |
| Net income                                           |       | $                     | 294,915    |                  | $          | 1,087,814 |   |
| Basic earnings  per share                            |       | $                     | 0.16       |                  | $          | 0.60 |   |
| Diluted earnings  per share                          |       | $                     | 0.16       |                  | $          | 0.59 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

4

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**CommerceFirst Bancorp, Inc. and Subsidiary**

**Consolidated Statements of Comprehensive Income**

**For the Years Ended December 31, 2008 and 2007**

 
| ** **                                                                            | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                            | ** ** | **2008**              | ** ** | **2007**              | ** ** |
| Net income                                                                            |       | $                     | 294,915    |                  | $          | 1,087,814 |   |
|                                                                                  |       |                  |       |                  |       |
| Reclassification  adjustment for gain included in net income, net of tax              |       | (28,679               | )          | —                |       |
|                                                                                  |       |                  |       |                  |       |
| Change in  unrealized gains and (losses) on securities available-for-sale, net of tax |       | (12,040               | )          | 111,912               |       |
|                                                                                  |       |                  |       |                  |       |
| Other  comprehensive income (loss)                                                    |       | (40,719               | )          | 111,912               |       |
|                                                                                  |       |                  |       |                  |       |
| Total  comprehensive income                                                           |       | $                     | 254,196    |                  | $          | 1,199,726 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

5

----

 

**CommerceFirst Bancorp, Inc. and Subsidiary**

**Consolidated Statements of Stockholders’ Equity**

**For the Years Ended December 31, 2008 and 2007**

** **
| ** **                                                                    | ** ** | **Common  Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Retained  Earnings** | ** ** | **Accumulated  Other  Comprehensive  Income (Loss)** | ** ** | **Total**  | ** ** |
|-------------------------------------------------------------------------------|------------|-------------------|------------|----------------------------------|------------|------------------------|------------|-----------------------------------------------------------|------------|------------|------------|
|                                                                          |       |              |       |                             |       |                   |       |                                                      |       |       |       |
| Balance  December 31, 2006                                               |       | $                 | 18,036     |                             | $          | 17,683,450             |       | $                                                         | 1,010,153  |       | $          | (24,654 | ) | $ | 18,686,985 |   |
|                                                                          |       |              |       |                             |       |                   |       |                                                      |       |       |       |
| Net income in  2007                                                           |       |              |       |                             |       | 1,087,814              |       |                                                      |       | 1,087,814  |       |
|                                                                          |       |              |       |                             |       |                   |       |                                                      |       |       |       |
| Net change in  unrealized gains and (losses) on securities available-for-sale |       |              |       |                             |       |                   |       | 111,912                                                   |       | 111,912    |       |
|                                                                          |       |              |       |                             |       |                   |       |                                                      |       |       |       |
| Proceeds from  warrant exercises                                              |       | 169               |       | 169,481                          |       |                   |       |                                                      |       | 169,650    |       |
|                                                                          |       |              |       |                             |       |                   |       |                                                      |       |       |       |
| Balance  December 31, 2007                                               |       | 18,205            |       | 17,852,931                       |       | 2,097,967              |       | 87,258                                                    |       | 20,056,361 |       |
|                                                                          |       |              |       |                             |       |                   |       |                                                      |       |       |       |
| Net income in  2008                                                           |       |              |       |                             |       | 294,915                |       |                                                      |       | 294,915    |       |
|                                                                          |       |              |       |                             |       |                   |       |                                                      |       |       |       |
| Net change in  unrealized gains and (losses) on securities available-for-sale |       |              |       |                             |       |                   |       | (40,719                                                   | )          | (40,719    | )          |
|                                                                          |       |              |       |                             |       |                   |       |                                                      |       |       |       |
| Balance  December 31, 2008                                               |       | $                 | 18,205     |                             | $          | 17,852,931             |       | $                                                         | 2,392,882  |       | $          | 46,539 |   | $ | 20,310,557 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

6

----

 

**CommerceFirst Bancorp, Inc. and Subsidiary**

**Consolidated Statements of Cash Flows**

**For the Years Ended December 31, 2008 and 2007**

 
| ** **                                                                               | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                               | ** ** | **2008**              | ** ** | **2007**              | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES                                                    |       |                  |       |                  |       |
| Net income                                                                               |       | $                     | 294,915    |                  | $          | 1,087,814 |   |
| Adjustments to  reconcile net income to net cash provided by operations:                 |       |                  |       |                  |       |
| Depreciation and  amortization                                                           |       | 294,009               |       | 233,681               |       |
| Gain on sale of  investment security                                                     |       | (40,431               | )          | —                |       |
| Gain on sales of  SBA loans                                                              |       | (241,220              | )          | (344,421              | )          |
| Provision for  loan losses                                                               |       | 647,105               |       | 45,383                |       |
| Provision for  losses on unfunded commitments                                            |       | 6,000                 |       | 6,000                 |       |
| Deferred income  taxes                                                                   |       | (91,524               | )          | (70,463               | )          |
| Change in assets  and liabilities:                                                       |       |                  |       |                  |       |
| Decrease  (increase) in accrued interest receivable                                      |       | 103,228               |       | (88,722               | )          |
| (Increase)  decrease in other assets                                                     |       | (253,650              | )          | 184,011               |       |
| Increase in  accrued interest payable                                                    |       | 63,852                |       | 25,414                |       |
| (Decrease)  increase in other liabilities                                                |       | (92,835               | )          | 210,096               |       |
| Other                                                                                    |       | 17,680                |       | 21,776                |       |
| Net cash  provided by operating activities                                               |       | 707,129               |       | 1,310,569             |       |
|                                                                                     |       |                  |       |                  |       |
| CASH FLOWS FROM  INVESTING ACTIVITIES                                                    |       |                  |       |                  |       |
| Investment in  securities – available for sale                                      |       | —                |       | (2,997,188            | )          |
| Maturities of  investment securities                                                     |       | 3,000,000             |       | 5,000,000             |       |
| Proceeds from  sale of investment security                                               |       | 3,039,375             |       | —                |       |
| Proceeds from  sales of SBA loans                                                        |       | 4,129,121             |       | 4,191,702             |       |
| Increase in  loans, net                                                                  |       | (30,966,385           | )          | (33,481,667           | )          |
| Purchase of  premises and equipment                                                      |       | (197,049              | )          | (753,584              | )          |
| Net cash used by  investing activities                                                   |       | (20,994,938           | )          | (28,040,737           | )          |
|                                                                                     |       |                  |       |                  |       |
| CASH FLOWS FROM  FINANCING ACTIVITIES                                                    |       |                  |       |                  |       |
| Increase in  non-interest bearing deposits, net                                          |       | 4,352,955             |       | 231,275               |       |
| Net increase in  other deposits                                                          |       | 17,480,259            |       | 10,971,831            |       |
| Net decrease in  securities sold under agreements to repurchase                          |       | (4,305,936            | )          | (5,273,180            | )          |
| Exercise of  warrants to purchase common stock                                           |       | —                |       | 169,650               |       |
| Net cash  provided by financing activities                                               |       | 17,527,278            |       | 6,099,576             |       |
|                                                                                     |       |                  |       |                  |       |
| Net decrease in  cash and cash equivalents                                               |       | (2,760,531            | )          | (20,630,592           | )          |
| Cash and cash  equivalents at beginning of period                                        |       | 11,724,888            |       | 32,355,480            |       |
| Cash and cash  equivalents at end of period                                              |       | $                     | 8,964,357  |                  | $          | 11,724,888 |   |
|                                                                                     |       |                  |       |                  |       |
| SUPPLEMENTAL  CASH FLOW INFORMATION                                                      |       |                  |       |                  |       |
| Interest paid                                                                            |       | $                     | 5,019,614  |                  | $          | 4,841,465 |   |
| Total (decrease)  increase in unrealized gains (losses) on available for sale securities |       | $                     | (65,306    | )                     | $          | 179,514 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

7

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**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 1. The Company and itsSignificant Accounting Policies**

 

CommerceFirst Bancorp, Inc.(the “Company”), through its wholly owned subsidiary, CommerceFirst Bank (the “Bank”)provides financial services to individuals and corporate customers located inAnne Arundel County and surrounding areas of Central Maryland, and is subjectto competition from other financial institutions.  The Company and the Bank are also subject to theregulations of certain Federal and State of Maryland agencies and undergoesperiodic examinations by those regulatory authorities.  The accounting policies of the Companyconform to accounting principles generally accepted in the United States ofAmerica and to general practices within the banking industry.

 

Principles ofConsolidation

 

The consolidatedfinancial statements include the accounts of CommerceFirst Bancorp, Inc.and its subsidiary, CommerceFirst Bank. Intercompany balances and transactions have been eliminated.  The Parent Only financial statements (seeNote 15) of the Company account for the subsidiary using the equity method ofaccounting.

 

Use of Estimates

 

The consolidatedfinancial statements have been prepared in conformity with accountingprinciples generally accepted in the United States of America. The preparationof the consolidated financial statements requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosures of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenue and expenses during thereporting periods. Actual results could differ significantly from thoseestimates. Material estimates that are particularly susceptible to significantchange in the near-term relate to the determination of the allowance for loanlosses. See below for a discussion of the determination of that estimate.

 

Investment Securities

 

Available-for-salesecurities consist of bonds and notes not classified as trading securities oras held-to-maturity securities. These securities are reported at their fairvalue with the unrealized holding gains and losses, net of tax, reported as anet amount in a separate component of stockholders’ equity until realized.Gains and losses on the sale of available-for-sale securities are determinedusing the specific identification method. Premiums and discounts are recognizedin interest income using the interest method over the period to maturity. TheCompany has no trading securities as of December 31, 2008 and 2007.

 

Securities for which theCompany has the positive intent and ability to hold to maturity are reported atcost, adjusted for premiums and discounts that are recognized in interestincome using the interest method over the period to maturity. A charge tooperations would occur if the fair value of the securities declines below costand the Company’s intention or ability to hold the securities to maturitychanges.  The Company has no investmentsecurities classified as held to maturity as of December 31, 2008 and2007.

 

Declines in the fairvalue of individual held-to-maturity and available-for-sale securities belowtheir cost that are other than temporary would result in write-downs of theindividual securities to their fair value. In estimating other-then-temporaryimpairment losses, management considers (1) the length of time and theextent to which the fair value has been less than cost, (2) the financialcondition and near-term prospects of the issuer, and (3) the intent andability of the Company to retain its investment in the issuer for a period oftime sufficient to allow for any anticipated recovery in the fair value. Therelated write-downs would be included in earnings as realized losses.

 

8

----

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 1.  The Company and its Significant AccountingPolicies (continued)**

 

Restricted Securities

 

As a member of theFederal Reserve Bank of Richmond (Federal Reserve), the Company is required toacquire and hold stock in this entity. Ownership of this stock is restricted to members and can only be sold toand acquired from the respective entity at par. The Company also owns stock in Atlantic Central Bankers Bank (ACBB) andMaryland Financial Bank (MFB), banks that generally offers product and servicesonly to other banks.  Ownership of theACBB shares is restricted to banks, and there is no active market for the ACBBor the MFB shares.  As there is noreadily determinable fair value for these securities, they are carried at cost.

 

Loans and Allowance forLoan Losses

 

Loans receivable thatmanagement has the intent and ability to hold for the foreseeable future oruntil maturity or pay-off are reported at their outstanding principal balanceadjusted for any charge-offs, the allowance for loan losses and any unamortizeddeferred fees, costs, premiums and discounts. Loan origination fees and certaindirect origination costs are capitalized and recognized as an adjustment of theyield of the related loan.

 

The accrual of intereston loans is discontinued when, in management’s opinion, the full collection ofprincipal or interest is in doubt or a scheduled loan payment has become overninety days past due. Interest received on non-accrual loans is applied againstthe loan principal amount.

 

The Company determinesand recognizes impairment of loans in accordance with the provisions ofStatement of Financial Accounting Standards No. 114, Accounting byCreditors for Impairment of a Loan as amended by Statement 118, Accounting byCreditors for Impairment of a Loan - Income Recognition and Disclosures. A loanis determined to be impaired when, based on current information and events, itis probable that the Company will be unable to collect all amounts due accordingto the contractual terms of the loan agreement. A loan is not consideredimpaired during the period of delay in payment if the Company expects tocollect all amounts due, including past-due interest. An impaired loan ismeasured at the present value of its expected future cash flows discounted atthe loan’s effective interest rate or at the loan’s observable market price orthe fair value of the collateral if the loan is collateral dependent. StatementNo. 114 is generally applicable to all loans except large groups ofsmaller balance homogeneous loans that are evaluated collectively forimpairment unless such loans are subject to a restructuring agreement. Interestpayments received are applied to the loan principal balance unless thecollection of all amounts due, both principal and interest, on the loan isconsidered probable, in which case the interest payments would be recognized asinterest income.

 

The allowance for loanlosses is increased by charges to expense and decreased by charge-offs (net ofrecoveries).  Management’s periodicdetermination and evaluation of the adequacy of the allowance assesses variousfactors including inherent losses in all significant loans; known deteriorationin concentrations of credit, certain classes of loans or collateral; historicalloss experiences; results of independent reviews of loan quality and theallowance for loan losses; trends in portfolio quality, maturity andcomposition; volumes and trends in delinquencies and non-accrual loans, riskmanagement policies and practices; lending policies and procedures; economicconditions and downturns in specific local industries; loss history; and theexperience and quality of lending management and staff.  Estimated losses in the portfolio aredetermined by applying loss ratios to loan categories, other than impairedloans and loans considered substandard or doubtful, which are evaluatedseparately to determine loss estimates.

 

The determination of theallowance for loan losses involves the use of various subjective estimates bymanagement and may result in over or under estimations of the amount ofinherent losses in the loan portfolio.

 

9

----

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 1.  The Company and its Significant AccountingPolicies (continued)**

 

Unearned Discounts andServicing Rights of SBA Loans Sold

 

The Company generallysells the SBA-guaranteed portions of its SBA loans in the secondarymarket.  In connection with such sales,the Company receives a cash premium related to the guaranteed portion beingsold.  A portion of the cash premiumreceived from the sale of the guaranteed portion of the SBA loan is deferred asa discount on retained premiums based on the relative fair value of theguaranteed and unguaranteed portions to the total loan and the remainder isrecognized as a gain at the time of the sale. The resulting unearned discount is recognized in interest income usingan adjustable interest method.

 

SBA loan servicing rightsare initially valued by allocating the total cost between the loan and theservicing right based on their relative fair values.  Since sales of SBA loans tend to occur inprivate transactions and the precise terms and conditions of the sales aretypically not readily available, there is a limited market to refer to indetermining the fair value of these servicing rights.  As such, the Company relies primarily on adiscounted cash flow model to estimate the fair value of its servicing rights.  This model calculates estimated fair value ofthese servicing rights by utilizing certain key characteristics such asinterest rates, type of product (fixed vs. variable), age (new, seasoned,moderate), and other factors.  Managementbelieves that the assumptions used in the model are comparable to those used bybrokers and other service providers.  TheCompany also compares its estimates of fair value and assumptions to recentmarket activity and against its own experience. The resulting servicing rights are recognized in other non-interestexpense using an adjustable interest method.

 

Other Real Estate Owned(OREO)

 

OREO is comprised of realestate properties acquired in partial or total satisfaction of problem loans.The properties are recorded at the lower of cost or fair value (appraisedvalue) at the date acquired. Losses occurring at the time of acquisition ofsuch properties are charged against the allowance for loan losses. Subsequentwrite-downs that may be required and expenses of operation for the propertiesare included in non-interest expenses. Gains and losses realized from the saleof OREO are included in other income or expenses. There is no OREO at December 31,2008 and no financing of OREO during 2008 or 2007.

 

Reserve forUnfunded Commitments

 

Thereserve for unfunded commitments is established through a provision forunfunded commitments charged to other expenses. The reserve is calculated by utilizing the same methodology and factorsas the allowance for loan losses.  Thereserve, based on evaluations of the collectability of loans and prior loanloss experience, is an amount that management believes will be adequate overtime to absorb possible losses on unfunded commitments (off-balance sheetfinancial instruments) that may become uncollectible in the future.

 

Premises and Equipment

 

Premises and equipmentare stated at cost less accumulated depreciation.  The provision for depreciation is computedusing the straight-line method over the estimated useful lives of the assets.  Leasehold improvements are depreciated over thelesser of the terms of the leases or their estimated useful lives.  Expenditures for improvements that extend thelife of an asset are capitalized and depreciated over the asset’s remaininguseful life.  Any gains or lossesrealized on the disposition of premises and equipment are reflected in theconsolidated statements of operations. Expenditures for repairs and maintenance are charged to other expensesas incurred.  Computer software isrecorded at cost and amortized over three years.

 

10

----

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 1.  The Company and its Significant AccountingPolicies (continued)**

 

Long-Lived Assets

 

The carrying value oflong-lived assets and identifiable intangibles is reviewed by the Company forimpairment whenever events or changes in circumstances indicate that thecarrying amount of an asset may not be recoverable as prescribed in SFAS No. 144,*Accounting for the Impairment or Disposal ofLong-Lived Asset*. At December 31, 2008 and 2007, certain loansexisted which management considered impaired (see Note 3).

 

Transfers of FinancialAssets

 

Transfers of financialassets are accounted for as sales when control over the assets has beensurrendered. Control over transferred assets is deemed to be surrendered when (1) theassets have been isolated from the Company, (2) the transferee obtains theright (free of conditions that constrain it from taking advantage of thatright) to pledge or exchange the transferred assets, and (3) the Companydoes not maintain effective control over the transferred assets through anagreement to repurchase them before their maturity.

 

Deferred Income Taxes

 

Deferred income taxes arerecognized for temporary differences between the financial reporting basis andthe income tax basis of assets and liabilities. Deferred tax assets arerecognized only to the extent that it is more likely than not that such amountswill be realized based on consideration of available evidence. The effect ondeferred tax assets and liabilities of a change in tax rates is recognized inincome in the period that includes the enactment date.

 

Securities Sold underAgreements to Repurchase

 

Securities sold underagreements to repurchase are accounted for as borrowings and recorded as aliability at the amount of the repurchase obligation. These transactions maturethe next business day. The Company’s repurchase obligations are secured byCompany owned securities with market values exceeding the obligations. Thesesecurities are segregated from other, non-pledged securities.

 

Concentration of CreditRisk

 

The Company grants loansto customers primarily in its market area in Maryland. The debtors’ ability tohonor their contracts, including borrowing agreements, may be influenced by theeconomic conditions in the Company’s lending area.

 

The Company maintainsdeposits with other banking institutions in amounts which can, at times, exceedinsurance limits of the Federal Deposit Insurance Corporation (FDIC). Suchinstitutions include the Federal Reserve Bank of Richmond and bankers’ banks.Further, the Company sells federal funds, which are not insured by the FDIC tothree banking entities.

 

Comprehensive Income orLoss

 

Unrealized gains andlosses on available for sale securities, net of tax, are reported as a separatecomponent of the equity section in the consolidated statement of financialcondition. Changes in the net unrealized gains and losses are components ofcomprehensive income or loss and are not included in reported net income orloss.

 

Statement of Cash Flows

 

Cash and cash equivalentsin the statement of cash flows include cash on hand, non-interest bearingamounts due from correspondent banks and the Federal Reserve and Federal fundssold.

 

11

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**Note1.  The Company and its SignificantAccounting Policies (continued)**

 

Earnings Per Share

 

Basic EPS is computedbased upon income available to common shareholders and the weighted averagenumber of common shares outstanding for the period. Diluted EPS reflects thepotential dilution that could occur if securities or other contracts to issuecommon stock were exercised or converted into common stock or resulted in theissuance of common stock that would share in the earnings of the Company, usingthe treasury stock method, unless they are anti-dilutive. The Company uses theaverage market price of the common shares during the year in the determinationof the amount of common stock equivalents arising from the warrants and optionsissued.

 

The weighted averagenumber of common shares and dilutive securities (comprised of warrants andoptions) and resultant per share computations are as follows:

 
| ** **                             | ** ** | **2008**  | ** ** | **2007**  | ** ** |
|----------------------------------------|------------|-----------|------------|-----------|------------|
| Weighted average  shares outstanding   |       | 1,820,548 |       | 1,816,504 |       |
| Common stock  equivalents              |       | —    |       | 31,691    |       |
| Average common  shares and equivalents |       | 1,820,548 |       | 1,848,195 |       |
| Net income                             |       | $         | 294,915    |      | $          | 1,087,814 |   |
| Basic earnings  per share              |       | $         | 0.16       |      | $          | 0.60 |   |
| Diluted earnings  per share            |       | $         | 0.16       |      | $          | 0.59 |   |

 

The warrants and optionswere excluded from the calculation of diluted income per share in 2008 becausethey are anti-dilutive.

 

Stock Options

 

On January 1, 2006,the Company adopted SFAS No. 123R, *Share-BasedPayments*, for accounting and reporting for stock-based compensationplans.  SFAS No. 123R defines a fairvalue at grant date based method of accounting for measuring compensationexpense for stock-based plans to be recognized in the statement ofoperations.  The Company did not recordany compensation expense under SFAS No. 123R during 2008 or 2007 as no newoptions were granted during the periods and all options under the existingplans were previously fully vested.

 

Fair Value

 

In September 2006,the FASB issued Statement No. 157 (SFAS 157), *Fair Value Measurements*. SFAS 157 defines fair value,establishes a framework for measuring fair value and expands disclosures aboutfair value measurements. SFAS 157 applies whenever other standards require (orpermit) assets or liabilities to be measured at fair value but does not expandthe use of fair value in any new circumstances. In this standard, the FASBclarifies the principle that fair value should be based on the assumptionsmarket participants would use when pricing the asset or liability. In supportof this principle, SFAS 157 establishes a fair value hierarchy that prioritizesthe information used to develop those assumptions. The hierarchy of valuationtechniques based on whether the inputs to those valuation techniques areobservable or unobservable. These inputs are summarized in the three broadlevels listed below:

 

o            Level 1 – Quoted prices in activemarkets for identical securities

 

o   Level 2 – Other significantobservable inputs (including quoted prices in active markets for similarsecurities)

 

o   Level 3 – Significantunobservable inputs (including the Company’s own assumptions in determining the fair value of investments)

 

12

----

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**Note1.  The Company and its SignificantAccounting Policies (continued)**

 

Fair Value (continued)

 

The Company’s bondholdings in the investment securities are the only asset or liability subjectto fair value measurement on a recurring basis. These assets are valued underLevel 1 inputs. Impaired loans are valued as to $3,650,723 under Level 2 inputswith the remainder impaired loan amounts of $2,168,416 ($1,327,987 afterspecific reserves) valued under Level 3inputs.

 

Reclassification

 

Certain prior years’amounts have been reclassified to conform to the current year’s method ofpresentation.

 

**Note 2. Investment Securities**

 

All investment securitiesare classified as available-for-sale securities and are summarized as follows:

 
| ** **                                   | ** ** | ** **    | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | **Estimated** | ** ** |
|----------------------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|---------------|------------|
| ** **                                   | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair**      | ** ** |
| ** **                                   | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **Losses**     | ** ** | **Value**     | ** ** |
| December 31,  2008:                     |       |          |       |           |       |           |       |          |       |
| U.S. Treasury  (due within one year)         |       | $             | 3,008,916  |           | $          | 76,854         |       | $             | —     |   | $ | 3,085,770 |   |
|                                         |       |          |       |           |       |           |       |          |       |
| December 31,  2007:                     |       |          |       |           |       |           |       |          |       |
| U.S. Treasury  (due within one year)         |       | $             | 3,004,529  |           | $          | 34,171         |       | $             | —     |   | $ | 3,038,700 |   |
| U.S. Treasury  (due over one to three years) |       | 6,021,011     |       | 107,989        |       | —         |       | 6,129,000     |       |
|                                         |       | $             | 9,025,540  |           | $          | 142,160        |       | $             | —     |   | $ | 9,167,700 |   |

 

In June 2008, a U.S.Treasury Note in the face amount of $3,000,000 and a carrying value (amortizedcost) of $2,998,944 was sold for $3,039,375 resulting in a gain on the sale of$40,431. There were no such sales during 2007.

 

Restricted securities arecomprised of common stock in the following entities at cost:

 
|                              |   |   |   | **December 31,** |    |     |   |
|-----------------------------------|--------|--------|--------|-----------------------|---------|----------|--------|
|                              |   |   |   | **2008**              |    | **2007** |   |   |   |
| Federal Reserve  Bank of Richmond |   |   |   | $                     | 405,000 |     | $      | 405,000 |   |   |   |
|                              |   |   |   |                  |    |     |   |   |   |
| Atlantic Central  Bankers Bank    |   |   |   | 37,000                |    | 37,000   |   |   |   |
|                              |   |   |   |                  |    |     |   |   |   |
| Maryland  Financial Bank          |   |   |   | 25,000                |    | 25,000   |   |   |   |
|                              |   |   |   | $                     | 467,000 |     | $      | 467,000 |   |   |   |

 

**Note 3.Loans**

 

The Bank grantscommercial loans to customers primarily in Anne Arundel County, Prince GeorgesCounty, Howard County and surrounding areas of central Maryland. The principalcategories of the loan portfolio are as follows:

 

13

----

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 3.Loans (continued)**

 

 
| ** **                              | ** ** | **December 31, 2008** | ** **  | **December 31, 2007** | ** ** |
|-----------------------------------------|------------|---------------------------------|-------------|---------------------------------|------------|
| ** **                              | ** ** | ** **                      | ** **  | **Percentage**                  | ** ** | ** ** | ** ** | **Percentage** | ** ** |
| ** **                              | ** ** | **Balance**                     | ** **  | **of Loans**               | ** ** | **Balance** | ** ** | **of Loans** | ** ** |
| Commercial &  industrial loans |       | $                               | 58,782,633  |                            | 38.4       | % | $ | 53,437,061 |   | 42.3 | % |
| Real estate  loans secured by:          |       |                            |        |                            |       |   |   |   |   |
| Residential real  estate                |       | 19,006,592                      |        | 12.4                            | %          | 12,100,261 |   | 9.6 | % |
| Commercial real  estate                 |       | 75,200,348                      |        | 49.2                            | %          | 60,833,133 |   | 48.1 | % |
| Total real  estate loans                |       | 94,206,940                      |        | 61.6                            | %          | 72,933,394 |   | 57.7 | % |
|                                    |       | 152,989,573                     |        | 100.0                           | %          | 126,370,455 |   | 100.0 | % |
| Unearned loan  fees, net                |       | (28,404                         | )           |                            |       | (35,665 | ) |   |   |
| Allowance for  loan losses              |       | (1,860,000                      | )           |                            |       | (1,665,000 | ) |   |   |
|                                    |       | $                               | 151,101,169 |                            |       |   | $ | 124,669,790 |   |   |   |

 

Loans secured byresidential real estate are loans to investors for commercial purposes. TheBank does not lend funds to consumers.

 

The allowance for loanlosses activity for the years ended December 31, 2008 and 2007 is asfollows:

 
| ** **                      | ** ** | **2008** | ** ** | **2007** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|
| Balance at  beginning of period |       | $        | 1,665,000  |     | $          | 1,613,693 |   |
| Provision for  loan losses      |       | 647,105  |       | 45,383   |       |
|                            |       |     |       |     |       |
| Commercial loans  charged off   |       | (497,510 | )          | (72,345  | )          |
| Commercial loans  recovery      |       | 45,405   |       | 78,269   |       |
| Net recovery  (charge off)      |       | (452,105 | )          | 5,924    |       |
| Balance at end  of period       |       | $        | 1,860,000  |     | $          | 1,665,000 |   |

 

Certain officers anddirectors (and companies in which they have a 10% or more beneficial ownership)have loans with the Bank. These loans are made on the same terms, includinginterest rates and collateral, as those prevailing at the time for comparableloans with unrelated borrowers.  They donot involve more than normal risk of collectability or present otherunfavorable terms. The activity of these loans during 2008 and 2007 is asfollows:

 
| ** **                             | ** ** | **2008**   | ** ** | **2007**   | ** ** |
|----------------------------------------|------------|------------|------------|------------|------------|
| Total loans at  beginning of year      |       | $          | 4,621,497  |       | $          | 5,837,347 |   |
| New loans and  funding during the year |       | 41,692     |       | 1,466,787  |       |
| Repayments  during the year            |       | (1,059,480 | )          | (2,682,637 | )          |
| Total loans at  end of year            |       | $          | 3,603,709  |       | $          | 4,621,497 |   |

 

Loanson which the accrual of interest has been discontinued amounted to $5,819,139and $1,124,951 at December 31,2008 and 2007, respectively.  Interest that would have been accrued underthe terms of these loans totaled $339,704 and $77,591 for the years ended December 31, 2008 and 2007, respectively.  The Bank has no commitments to loanadditional funds to the borrowers of impaired or non-accrual loans.

 

14

----

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 3. Loans (continued)**

 

Non-accrual loan activity is summarized asfollows since December 31, 2007:

 
| ** **                             | ** ** | **LOAN  AMOUNT** | ** ** |
|----------------------------------------|------------|------------------|------------|
|                                   |       |             |       |
| Balance at December 31, 2007      |       | $                | 1,124,951  |   |
| New loans placed on non-accrual        |       | 5,046,399        |       |
| Less:                                  |       |             |       |
| Payments on loans applied to principal |       | 116,446          |       |
| Charge offs                            |       | 235,765          |       |
| Balance at December 31, 2008      |       | $                | 5,819,139  |   |

 

Includedin the amount of non-accrual loans at December 31, 2008 are loans to threeborrowers totaling $3,650,723 which are well secured by real estate and onereal estate loan in the amount of $787,535 for which a valuation allowance of$58,278 has been established.

 

Informationregarding loans classified as impaired follows:

 
| ** **                                              | ** ** | **2008**  | ** ** | **2007** | ** ** |
|---------------------------------------------------------|------------|-----------|------------|----------|------------|
| Loans classified  as impaired with specific reserves    |       | $         | 1,892,056  |     | $          | 1,365,713 |   |
| Loans classified  as impaired with no specific reserves |       | $         | 3,927,083  |     | —     |   |
| Allowance for  loan losses on impaired loans            |       | 840,429   |       | 693,321  |       |
| Average balance  of impaired loans during year          |       | 2,141,744 |       | 740,000  |       |
|                                                         |            |           |            |          |            |  |  |

 

The classified loanswith specific reserves at December 31, 2008 include a non-accrual loan inthe amount of $483,014 ($583,014 at December 31, 2007) which is theremaining balance of a relationship totaling $958 thousand classified andplaced in non-accrual status prior to 2007. This loan is secured by anassignment of life insurance proceeds. The specific reserve allocated to this loan is $325,514. Also includedis a loan secured by commercial real estate in the amount of $787,535 for which a specific reserve of $58,278 hasbeen established. Two loans to one borrower totaling $263,606 have specificreserves established at the loan amounts. The remaining balance of classifiedloans for which specific reserves at December 31, 2008 have beenestablished is comprised of seven loans to five borrowers in variousstages of collection.

 

The classified loans forwhich no specific reserve has been established include three loans well securedby commercial real estate in the amount of $3,650,723. The remaining balance of classified loans for which no specific reserveshave been established at December 31, 2008 is comprised of four loans invarious stages of collection.

 

The Bank has restructured the scheduled payment amounts from the originalnotes on two loans totaling less than $300,000 at December 31,2008 (none at December 31, 2007).The loans are included above and have specific reserves established for theamount of the loans.

 

At December 31, 2008and 2007, the balance of commercial and real estate loans serviced by theCompany for others under loan participation agreements was $22,676,966 and$21,538,205, respectively.  The relatedservicing rights are not material and are included in other assets.

 

15

----

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**Note 4. Premises and Equipment**

 

Property, equipment andleasehold improvements are as follows at December 31:

 
| ** **                                 | ** ** | **Useful** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                 | ** ** | **Lives**  | ** ** | **2008**   | ** ** | **2007**   | ** ** |
| Equipment                                  |       | 3-10 years |       | $          | 686,198    |       | $          | 504,455 |   |
| Furniture and fixtures                     |       | 3-5 years  |       | 240,026    |       | 226,670    |       |
| Leasehold  improvements                    |       | 4-10 years |       | 756,292    |       | 756,292    |       |
| Software                                   |       | 3 years    |       | 27,165     |       | 25,215     |       |
|                                       |       |       |       | 1,709,681  |       | 1,512,632  |       |
| Accumulated  depreciation and amortization |       |       |       | 708,714    |       | 414,705    |       |
| Net                                        |       |       |       | $          | 1,000,967  |       | $          | 1,097,927 |   |

 

**Note 5.****Deposits**

 

Interest bearing depositsare summarized below as of December 31:

 
| ** **                         | ** ** | **2008**   | ** **  | **2007**   | ** ** |
|------------------------------------|------------|------------|-------------|------------|------------|
|                               |       |       |        |       |       |
| NOW accounts                       |       | $          | 1,247,466   |       | $          | 2,440,058 |   |
| Money Market  accounts             |       | 13,049,169 |        | 16,267,872 |       |
| Savings accounts                   |       | 147,096    |        | 35,873     |       |
| Certificates of  deposit accounts: |       |       |        |       |       |
| Less than  $100,000                |       | 37,538,787 |        | 11,382,566 |       |
| $100,000 or more                   |       | 69,659,700 |        | 74,035,590 |       |
|                               |       | $          | 121,642,218 |       | $          | 104,161,959 |   |

 

The time deposit accountsmature and/or re-price as follows: within one year $84,587,073; one throughthree years- $21,628,578; three years and beyond- $982,836.

 

Interest expense oninterest bearing deposits is as follows:

 
| ** **                                 | ** ** | **2008**  | ** ** | **2007**  | ** ** |
|--------------------------------------------|------------|-----------|------------|-----------|------------|
|                                       |       |      |       |      |       |
| NOW accounts                               |       | $         | 2,938      |      | $          | 32,047 |   |
| Money Market  accounts                     |       | 321,781   |       | 715,438   |       |
| Savings accounts                           |       | 162       |       | 1,399     |       |
| Certificates of  deposit, $100,000 or more |       | 3,671,349 |       | 3,539,967 |       |
| Other  certificates of deposit             |       | 1,057,384 |       | 486,423   |       |
|                                       |       | $         | 5,053,614  |      | $          | 4,775,274 |   |

 

Deposit and repurchaseagreement balances of executive officers and directors and their affiliatedinterests totaled approximately $15,981,000 and $19,006,000 at December 31,2008 and 2007, respectively.

 

Included in certificatesof deposits are $50,099,276 and$22,543,783 of brokered certificates with weighted average interest rates of3.87% and 5.57% at December 31,2008 and 2007, respectively.  Included inthe brokered deposits at December 31, 2008 is $15,963,651 of certificatesof deposits received in exchange for the placement of the Bank’s customers’deposit funds in the same amounts with other financial institutions under theCertificate of Deposit Account Registry Service (CDARS) program.

 

16

----

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 6. Short-term borrowings**

 

The Bank entered intosales of securities under agreements to repurchase the same securities withcommercial customers, which mature the next business day.  The amortized cost of these pledgedsecurities at December 31, 2007was $6,027,301.  The fair value of these securities at December 31, 2007 was $6,122,100. The Bank discontinued thisprogram in December 2008. Information concerning securities sold underagreements to repurchase at and during the year ended December 31, 2008and 2007 is summarized as follows:

 
| ** **                             | ** ** | **2008** | ** ** | **2007** | ** ** |
|----------------------------------------|------------|----------|------------|----------|------------|
| Total  outstanding at year-end         |       | $        | —     |     | $          | 4,305,936 |   |
| Average balance  during the year       |       | $        | 2,650,978  |     | $          | 3,494,779 |   |
| Average interest  rate during the year |       | 1.12     | %          | 2.62     | %          |

 

The Bank has receivedapproval of unsecured credit facilities for short-term liquidity needs fromfinancial   institutions of $8,500,000 at December 31, 2008and 2007. There were no borrowings outstanding under these credit arrangementsat December 31, 2008 and 2007.

 

**Note 7. Income Taxes**

 

The income tax expenseconsists of the following for the years ended December 31, 2008 and 2007:

 
| ** ** | ** ** | **2008** | ** ** | **2007** | ** ** |
|------------|------------|----------|------------|----------|------------|
| Current:   |       |     |       |     |       |
| Federal    |       | $        | 217,239    |     | $          | 642,299 |   |
| State      |       | 40,682   |       | 122,669  |       |
|       |       | 257,921  |       | 764,968  |       |
| Deferred:  |       |     |       |     |       |
| Federal    |       | (56,749  | )          | (19,073  | )          |
| State      |       | (34,775  | )          | (51,390  | )          |
|       |       | (91,524  | )          | (70,463  | )          |
|       |       | $        | 166,397    |     | $          | 694,505 |   |

 

The reasons for thedifferences between the statutory federal income tax rates are summarized asfollows:

 
| ** **                                     | ** ** | **2008** | ** ** | **2007** | ** ** |
|------------------------------------------------|------------|----------|------------|----------|------------|
| Federal tax at  statutory rates                |       | $        | 156,846    |     | $          | 605,988 |   |
| State income  taxes net of federal tax benefit |       | 18,073   |       | 68,374   |       |
| Other                                          |       | (8,522   | )          | 20,143   |       |
|                                           |       | $        | 166,397    |     | $          | 694,505 |   |

 

The deferred income taxaccount is comprised of the following at December 31, 2008 and 2007:

 
| ** **                          | ** ** | **2008** | ** ** | **2007** | ** ** |
|-------------------------------------|------------|----------|------------|----------|------------|
| Deferred tax  assets:               |       |     |       |     |       |
| Allowance for  loan losses          |       | $        | 647,795    |     | $          | 639,103 |   |
| Deferred  compensation accrual      |       | 95,496   |       | 39,469   |       |
| Other                               |       | 18,934   |       | 16,221   |       |
|                                |       | 762,225  |       | 694,793  |       |
| Deferred tax  liabilities:          |       |     |       |     |       |
| Accumulated  depreciation           |       | 63,917   |       | 88,009   |       |
| Unrealized gain  on securities, net |       | 30,315   |       | 54,902   |       |
|                                |       | 94,232   |       | 142,911  |       |
| Net deferred tax  assets            |       | $        | 667,993    |     | $          | 551,882 |   |

 

17

----

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 8. Commitments andContingencies**

 

The Bank is a party tofinancial instruments in the normal course of business to meet the financingneeds of its customers.  These financialinstruments include commitments to extend credit and standby letters of credit,which involve, to varying degrees, elements of credit and interest rate risk inexcess of the amounts recognized in the consolidated financial statements.

 

Outstanding loancommitments, un-advanced loan funds and standby letters of credit areapproximately as follows:

 
| ** **                 | ** ** | **2008**  | ** ** |
|----------------------------|------------|-----------|------------|
| Loan  commitments:         |       |      |       |
| Commercial                 |       | $         | 1,613,000  |   |
| Commercial real  estate    |       | 3,480,000 |       |
|                       |       | $         | 5,093,000  |   |
|                       |       |      |       |
| Un-advanced loan  funds:   |       |      |       |
| Commercial                 |       | $         | 28,576,000 |   |
| Commercial real  estate    |       | 9,253,000 |       |
|                       |       | $         | 37,829,000 |   |
|                       |       |      |       |
| Standby letters  of credit |       | $         | 1,573,000  |   |

 

At December 31,2007, loan commitments, un-advanced loan funds and standby letters of credittotaled $16,857,000, $41,500,000 and $1,970,000, respectively.

 

Loan commitments andun-advanced loan funds are agreements to lend funds to customers under loancommitment contracts and loan agreements as long as the borrowers are incompliance with the loan commitment contracts and loan agreements.  Loan commitments generally have interestrates reflecting current market conditions, fixed expiration dates, and mayrequire payment of a fee.  Funding underloans with un-advanced loan funds generally have variable interest rates.  Some of the loan commitments and un-advancedloan funds are expected to expire or not be used without being drawn upon;accordingly, the total commitment amounts do not necessarily represent futurecash requirements.  The Bank evaluateseach customer’s creditworthiness on a case-by-case basis.  The amount of collateral or other securityobtained, if deemed necessary by the Bank upon extension of credit, is based onthe Bank’s credit evaluation.

 

Standby letters of creditare conditional commitments issued by the Bank to guarantee the performance ofa customer to a third party.  Thoseguarantees are primarily issued to guarantee the installation of real propertyimprovements and similar transactions. The credit risk involved in issuing letters of credit is essentially thesame as that involved in extending loan facilities to customers.  The Bank holds collateral and obtainspersonal guarantees supporting those commitments for which collateral or othersecurities is deemed necessary.

 

The Bank’s exposure tocredit loss in the event of nonperformance by the customer is the contractualamount of the commitment.  Loancommitments and standby letters of credit are made on the same terms, includingcollateral, as outstanding loans.  As of December 31,2008 and 2007 the Bank has accrued $48,000and $42,000, respectively, for unfunded commitments related to these financialinstruments with off balance sheet risk, which is included in other liabilities

 

The Bank has entered intoleases for its branches and office space, most of which contain renewal optionsand expense sharing provisions. The minimum net non-cancelable future rentalcommitments at December 31, 2008 are as follows:

 

18

----

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 8. Commitments andContingencies (continued)**

 
| **Year Ending**  | ** ** | ** ** | ** ** |
|-----------------------|------------|------------|------------|
| **December 31,** | ** ** | ** ** | ** ** |
| 2009                  |       | $          | 408,781    |   |
| 2010                  |       | 266,227    |       |
| 2011                  |       | 191,943    |       |
| 2012                  |       | 106,438    |       |
| 2013                  |       | 105,283    |       |
| 2014                  |       | 97,464     |       |
| Beyond                |       | 104,831    |       |
|                       |            |            |            |  |

 

The related net rentexpense was $454,233 and $429,740 in 2008 and 2007, respectively.

 

**Note9.  Regulatory Matters**

 

The Company and the Bankare subject to various regulatory capital requirements administered by thefederal banking agencies. Failure to meet minimum capital requirements caninitiate certain mandatory - and possibly additional discretionary - actions byregulators that, if undertaken, could have a direct material effect on theCompany’s financial statements. Under capital adequacy guidelines and theregulatory framework for prompt corrective action, the Bank must meet specificcapital guidelines that involve quantitative measures of assets, liabilitiesand certain off-balance-sheet items as calculated under regulatory accountingpractices. The Company will be subject to the capital guidelines when itsassets exceed $500 million, it engages in certain highly leveraged activitiesor it has publicly issued debt. The Company’s and the Bank’s capital amountsand classification are also subject to qualitative judgments by the regulatorsabout components, risk weightings and other factors. The Company and the Bankmust maintain minimum capital and other requirements of regulatory authoritieswhen declaring and paying dividends. The Company and the Bank are in compliancewith such capital requirements. Banking regulations limit the amount ofdividends that may be paid to the Company without prior approval of the Bank’sregulatory agencies.  Regulatory approvalis required to pay dividends that exceed the Bank’s net profits for the currentyear plus its retained net profits for the preceding two years.

 

Quantitative measuresestablished by regulation to ensure capital adequacy require the Company andthe Bank to maintain minimum amounts and ratios (set forth in the table below)of total and Tier I capital (as defined in the regulation) to risk-weightedassets (as defined), and of Tier I capital to average assets (as defined).Management believes, as of December 31, 2008, that the Company and theBank meet capital adequacy requirements to which they are subject. As of December 31,2008, the most recent notification from the regulators categorized the Bank aswell capitalized under the regulatory framework for prompt corrective action.To be categorized as well capitalized the Bank must meet minimum totalrisk-based, Tier I risk-based and Tier I leverage ratios. There are noconditions or events since that notification that management believes havechanged the Company’s and the Bank’s category.

 

Actual capital amountsand ratios are presented in the table below:

 
| ** **                                 | ** ** | **Actual** | ** ** | **For Capital  Adequacy  Purposes** | ** ** | **To be “Well Capitalized  For Purposes of Prompt  Corrective Action** | ** ** |
|--------------------------------------------|------------|------------|------------|------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------|------------|
| **December 31, 2008**            | ** ** | **Amount** | ** ** | **Ratio**                                | ** ** | **Amount**                                                                                                     | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| Total Capital (to  risk weighted assets):  |       |       |       |                                     |       |                                                                                                           |       |   |   |   |   |   |   |
| Company                                    |       | $          | 22,195,139 |                                     | 14.1       | %                                                                                                              | $          | 12,555,275 | >  | 8.0 | % | N/A |   |   |   |
| Bank                                       |       | 18,590,109 |       | 11.9                                     | %          | 12,555,149                                                                                                     | >  | 8.0 | % | $ | 15,693,936 | >  | 10.0 | % |
| Tier I Capital  (to risk weighted assets): |       |       |       |                                     |       |                                                                                                           |       |   |   |   |   |   |   |
| Company                                    |       | 20,264,018 |       | 12.9                                     | %          | 6,277,637                                                                                                      | >  | 4.0 | % | N/A |   |   |   |
| Bank                                       |       | 16,682,109 |       | 10.6                                     | %          | 6,277,574                                                                                                      | >  | 4.0 | % | 9,416,362 | >  | 6.0 | % |
| Tier I Capital  (to average assets):       |       |       |       |                                     |       |                                                                                                           |       |   |   |   |   |   |   |
| Company                                    |       | 20,264,018 |       | 12.2                                     | %          | 6,622,065                                                                                                      | >  | 4.0 | % | N/A |   |   |   |
| Bank                                       |       | 16,682,109 |       | 10.1                                     | %          | 6,618,837                                                                                                      | >  | 4.0 | % | 8,273,547 | >  | 5.0 | % |
|                                            |            |            |            |                                          |            |                                                                                                                |            |  |  |  |  |  |  |  |  |  |

 

19

----

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

**Note9.  Regulatory Matters (continued)**

 
| ** **                                 | ** ** | **Actual** | ** ** | **For Capital  Adequacy  Purposes** | ** ** | **To be “Well Capitalized  For Purposes of Prompt  Corrective Action** | ** ** |
|--------------------------------------------|------------|------------|------------|------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------|------------|
| **December 31, 2007**            | ** ** | **Amount** | ** ** | **Ratio**                                | ** ** | **Amount**                                                                                                     | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| Total Capital (to  risk weighted assets):  |       |       |       |                                     |       |                                                                                                           |       |   |   |   |   |   |   |
| Company                                    |       | $          | 21,619,110 |                                     | 16.5       | %                                                                                                              | $          | 7,619,946 | >  | 8.0 | % | N/A |   |   |   |
| Bank                                       |       | 17,923,724 |       | 13.7                                     | %          | 10,491,488                                                                                                     | >  | 8.0 | % | $ | 13,114,360 | >  | 10.0 | % |
| Tier I Capital  (to risk weighted assets): |       |       |       |                                     |       |                                                                                                           |       |   |   |   |   |   |   |
| Company                                    |       | 19,969,103 |       | 15.2                                     | %          | 5,245,948                                                                                                      | >  | 4.0 | % | N/A |   |   |   |
| Bank                                       |       | 16,273,717 |       | 12.4                                     | %          | 5,245,744                                                                                                      | >  | 4.0 | % | 7,868,616 | >  | 6.0 | % |
| Tier I Capital  (to average assets):       |       |       |       |                                     |       |                                                                                                           |       |   |   |   |   |   |   |
| Company                                    |       | 19,969,103 |       | 13.9                                     | %          | 5,741,363                                                                                                      | >  | 4.0 | % | N/A |   |   |   |
| Bank                                       |       | 16,273,717 |       | 11.3                                     | %          | 5,741,162                                                                                                      | >  | 4.0 | % | 7,176,452 | >  | 5.0 | % |
|                                            |            |            |            |                                          |            |                                                                                                                |            |  |  |  |  |  |  |  |  |  |

 

**Note 10. Warrant and Option Plans**

 

At December 31, 2008there were 106,372 fully vested warrants outstanding. During 2007, 16,965warrants were exercised at $10 per share. No warrants were exercisedduring 2008. The exercise price of each warrant is $10 per share and must beexercised, unless earlier called by the Company, not later than 10 years from August 18,2000.  Generally, vested warrants alsoexpire 90 days following the date that the warrant holder ceases to be adirector of the Bank.  Warrants may becalled by the Company in the event that a merger, sale, acquisition, shareexchange or other similar extraordinary event is approved by the Board ofDirectors of the Company.  Upon call bythe Company, warrant holders have 90 days in which to exercise theirwarrants.  If they are not exercised, theCompany will pay the warrant holder the difference between the exercise priceof the warrant and the fair market value of the stock of the Company at thetime of the closing of the transaction. In the event that an applicable Federal or state regulatory authoritydetermine that the Bank’s capital fails to meet minimum capital requirements,such regulatory authority may direct the Company to call all outstandingwarrants.  Any warrants not exercisedwill be thereafter forfeited.

 

TheBoard of Directors of the Company also adopted a stock option plan as aperformance incentive for three of the Bank’s officers and key employees.  The employment contracts obligated theCompany to issue 20,000 non-transferable stock options at an exercise price of$10 per share.  At December 31, 2008 all stockoptions had been issued by the Company and were fully vested, of which nooptions had been exercised.

 

**Note 11. Employee Benefit Plans**

 

TheBank has employee benefit programs that include health and dental insurance,life and long-term and short-term disability insurance and a 401(k) retirementplan.  Under the 401(k) plan, theBank made a 50% match of eligible employee contributions up to 6% of basesalary in 2008 and 2007. The Bank’s contributions to theplan included in compensation and benefits, totaled $43,460 and $43,776 for the years ended December 31, 2008 and 2007, respectively.

 

**Note 12. Related PartyTransactions**

 

The Bank paid $148,085 and $208,380 during the yearsended December 31, 2008 and 2007 respectively, for various group insurancebenefits for which a Director will ultimately receive compensation. The Bankpaid $58,841 and $43,913 duringthe years ended December 31, 2008 and 2007 respectively, to a computerservices firm of which a Director is also a principal.  Expenditures included computer hardware,software, installation, training, compliance and real-time support.

 

Expenditures totalingless than $25,000 were paid to several entities in which directors wereprincipals during 2008 and 2007.

 

All of the abovetransactions have been consummated on terms equivalent to those that prevail inarms length transactions.

 

20

----

** **

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**Note 13.  Fair Values of Financial Instruments**

 

The estimated fair valuesof the Company’s financial instruments at December 31, 2008 and 2007 aresummarized below. The fair values of a significant portion of these financialinstruments are estimates derived using present value techniques and may not beindicative of the net realizable or liquidation values. Also, the calculationof estimated fair values is based on market conditions at a specific point intime and may not reflect current or future fair values.

 
| ** **                                      | ** ** | **December 31, 2008** | ** ** | **December 31, 2007** | ** ** |
|-------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| **(In thousands)**                         | ** ** | **Carrying  Amount**            | ** ** | **Fair  Value**                 | ** ** | **Carrying  Amount** | ** ** | **Fair  Value** | ** ** |
| Financial  assets:                              |       |                            |       |                            |       |   |   |   |   |
| Cash and due  from banks                        |       | $                               | 3,291      |                            | $          | 3,291 |   | $ | 3,002 |   | $ | 3,002 |   |
| Federal funds  sold                             |       | 5,674                           |       | 5,674                           |       | 8,723 |   | 8,723 |   |
| Investment  securities                          |       | 3,086                           |       | 3,086                           |       | 9,168 |   | 9,168 |   |
| Investments in  restricted stock                |       | 467                             |       | 467                             |       | 467 |   | 467 |   |
| Loans, net                                      |       | 151,101                         |       | 158,169                         |       | 124,670 |   | 130,277 |   |
| Accrued interest  receivable                    |       | 640                             |       | 640                             |       | 743 |   | 743 |   |
|                                            |       |                            |       |                            |       |   |   |   |   |
| Financial  liabilities:                         |       |                            |       |                            |       |   |   |   |   |
| Non-interest  bearing deposits                  |       | $                               | 23,599     |                            | $          | 23,599 |   | $ | 19,246 |   | $ | 19,246 |   |
| Interest bearing  deposits                      |       | 121,642                         |       | 124,499                         |       | 104,162 |   | 106,580 |   |
| Securities sold  under agreements to repurchase |       | —                          |       | —                          |       | 4,306 |   | 4,306 |   |
| Accrued interest  payable                       |       | 265                             |       | 265                             |       | 201 |   | 201 |   |
|                                            |       |                            |       |                            |       |   |   |   |   |
| Off-balance  sheet commitments                  |       | —                          |       | —                          |       | — |   | — |   |

 

Fair values are based onquoted market prices for similar instruments or estimated using discounted cashflows. The discounts used are estimated using comparable market rates forsimilar types of instruments adjusted to be commensurate with the credit risk,overhead costs and optionality of such instruments.

 

The fair value of cashand due from banks, federal funds sold, investments in restricted stocks andaccrued interest receivable are equal to the carrying amounts. The fair valuesof investment securities are determined using market quotations. The fair valueof loans receivable is estimated using discounted cash flow analysis.

 

The fair value ofnon-interest bearing deposits, interest-bearing checking, savings, and moneymarket deposit accounts, securities sold under agreements to repurchase, andaccrued interest payable are equal to the carrying amounts. The fair value offixed-maturity time deposits is estimated using discounted cash flow analysis.

 

## **Note14. Recently Issued Accounting Pronouncements**

 

In February 2007,the FASB issued SFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities-including an amendment of FASBStatement No. 115*which is effective as of the beginning of thefirst fiscal year that begins after November 15, 2007. Management has notelected to adopt this SFAS but will continue to evaluate the impact of adoptingthis Statement on the Company’s financial statements for future periods.

 

In December 2007,the FASB issued SFAS 141, Revised 2007 (SFAS 141R), *BusinessCombinations.*  SFAS 141R’sobjective is to improve the relevance, representational faithfulness, andcomparability of the information that a reporting entity provides in itsfinancial reports about a business combination and its effects.  SFAS 141R applies to business combinationsfor which the acquisition date is on or after December 31, 2008.  The Company does not expect theimplementation of SFAS 141R to have a material impact on its consolidatedfinancial statements.

 

21

----

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

## **Note14. Recently Issued Accounting Pronouncements (continued)**

 

In December 2007,the FASB issued SFAS 160, *Noncontrolling Interestsin Consolidated Financial Statements.*  SFAS 160’s objective is to improve therelevance, comparability, and transparency of the financial information that areporting entity provides in its consolidated financial statements byestablishing accounting and reporting standards for the noncontrolling interestin a subsidiary and for the deconsolidation of a subsidiary.  SFAS 160 shall be effective for fiscal yearsand interim periods within those fiscal years, beginning on or after December 15,2008.  The Company does not expect theimplementation of SFAS 160 to have a material impact on its consolidatedfinancial statements.

 

On January 1, 2008,the Company adopted Emerging Issue Task Force Issue (“EITF”) No. 06-04, *Accounting for Deferred Compensation andPostretirement Benefit Aspects of Endorsement Split-Dollar Life InsuranceAgreements,* which established recognition of a liability and relatedcompensation costs for endorsement split-dollar life insurance arrangementsthat provide a benefit to an employee that extends to postretirement periods.The adoption of this EITF did not have an impact on the Company’s consolidatedfinancial statements.

 

On January 12, 2009,the FASB issued FASB Staff Position EITF 99-20-1, *Amendmentsto the Impairment Guidance of EITF Issue No. 99-20*(FSP). FASBFSP 99-20-1 amends the impairment guidance in FASB EITF Issue No. 99-20, *Recognition of Interest Income and Impairment on Purchased BeneficialInterests and Beneficial Interests that Continue to be held by a Transferor inSecuritized Financial Assets*. The intent of the FSP is to reducecomplexity and achieve more consistent determinations as to whetherother-than-temporary impairments of available for sale or held to maturity debtsecurities have occurred. The FSP is effective for interim and annual reportingperiods ending after December 15, 2008. The adoption of this FSP did nothave an impact on the Company’s consolidated financial statements.

 

In March 2008, theFASB issued SFAS No. 161, “*Disclosuresabout Derivative Instruments and Hedging Activities — an Amendment of FASBStatement No. 133*.” This Statement amends and expands thedisclosure requirements of SFAS No. 133, “*Accountingfor Derivative Instruments and Hedging Activities*.” The Statementrequires qualitative disclosures about objectives and strategies for usingderivatives, quantitative disclosures about fair value amounts of and gains andlosses on derivative instruments, and disclosures about credit-risk-relatedcontingent features in derivative agreements. This Statement is effective forfinancial statements issued for fiscal years and interim periods beginningafter November 15, 2008. The Company does not expect that the adoption ofthis Statement will have a material impact on the Company’s consolidatedfinancial statements.

 

In May 2008, theFASB issued SFAS No. 162, “The *Hierarchyof Generally Accepted Principles*.” This statement identifies thesources of accounting principles and the framework for selecting the principlesused in the preparation of financial statements of nongovernmental entitiesthat are presented in conformity with generally accepted accounting principles(“GAAP”) in the United States. The Statement is directed to entities ratherthan auditors because entities are responsible for the selection of accountingprinciples for financial statements that are presented in conformity with GAAP.This Statement is effective 60 days following the SEC’s approval of the PublicCompany Accounting Oversight Board amendments to AU Section 411, “*The Meaning of Present Fairly in Conformity WithGenerally Accepted Accounting Principles*.” The Company does notexpect that the adoption of this Statement will have a material impact on itsconsolidated financial statements.

## ** **

22

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**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

## **Note15. Parent Company Financial Information**

 

Information as to thefinancial position of CommerceFirst Bancorp, Inc. as of December 31,2008 and 2007 and results of operations and cash flows for the years then endedfollows:

 
| ** **                                           | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| **Statements of Financial Condition** | ** ** | **2008**              | ** ** | **2007**              | ** ** |
| **Assets**                                           |       |                  |       |                  |       |
| Cash in  CommerceFirst Bank                          |       | $                     | 3,615,334  |                  | $          | 3,700,274 |   |
| Investment in  subsidiary                            |       | 16,728,648            |       | 16,360,975            |       |
| Other assets                                         |       | 1,575                 |       | 5,112                 |       |
|                                                 |       | $                     | 20,345,557 |                  | $          | 20,066,361 |   |
| **Liabilities and Stockholders’ Equity**        |       |                  |       |                  |       |
| Accrued expenses                                     |       | $                     | 35,000     |                  | $          | 10,000 |   |
| Stockholders’  equity                           |       | 20,310,557            |       | 20,056,361            |       |
|                                                 |       | $                     | 20,345,557 |                  | $          | 20,066,361 |   |

 
| **Statements of Operations**                                                    | ** ** | **Year ended  December 31,  2008** | ** ** | **Year ended  December 31,  2007** | ** ** |
|-------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| Interest income  from deposit in CommerceFirst Bank                                       |       | $                                            | 1,575      |                                         | $          | — |   |
| Administrative  expenses                                                                  |       | 173,510                                      |       | 123,003                                      |       |
| Loss before  equity in undistributed net income of bank subsidiary and income tax benefit |       | (171,935                                     | )          | (123,003                                     | )          |
| Income tax  benefit                                                                       |       | 58,458                                       |       | 41,821                                       |       |
| Loss before  equity in undistributed net income of bank subsidiary                        |       | (113,477                                     | )          | (81,182                                      | )          |
| Equity in  undistributed net income of bank subsidiary                                    |       | 408,392                                      |       | 1,168,996                                    |       |
| Net income                                                                                |       | $                                            | 294,915    |                                         | $          | 1,087,814 |   |

 
| **Statements of Cash Flows**          | ** ** | **Year ended  December 31,  2008** | ** ** | **Year ended  December  31, 2007** | ** ** |
|------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| Cash flows from  operating activities:               |       |                                         |       |                                         |       |
| Net income                                           |       | $                                            | 294,915    |                                         | $          | 1,087,814 |   |
| Equity in  undistributed earnings of bank subsidiary |       | (408,392                                     | )          | (1,168,996                                   | )          |
| Decrease  (increase) in other assets                 |       | 3,537                                        |       | (5,112                                       | )          |
| Increase in  payables                                |       | 25,000                                       |       | 10,000                                       |       |
| Net cash used in  operating activities               |       | (84,940                                      | )          | (76,294                                      | )          |
|                                                 |       |                                         |       |                                         |       |
| Cash flows from  financing activities:               |       |                                         |       |                                         |       |
| Proceeds from  warrant exercises                     |       | —                                       |       | 169,650                                      |       |
| Net cash  provided by financing activities           |       | —                                       |       | 169,650                                      |       |
|                                                 |       |                                         |       |                                         |       |
| Increase  (decrease) in cash and cash equivalents    |       | (84,940                                      | )          | 93,356                                       |       |
| Cash and cash  equivalents at beginning of period    |       | 3,700,274                                    |       | 3,606,918                                    |       |
| Cash and cash  equivalents at end of period          |       | $                                            | 3,615,334  |                                         | $          | 3,700,274 |   |

 

**23**

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** **

**Directors & Officers**

**of**

**CommerceFirstBancorp, Inc. and CommerceFirst Bank**

 

**MiltonD. Jernigan II, Esquire***

**Chairmanof the Board**

### **Managing Partner**

**McNamee,Hosea, Jernigan, Kim, Greenan & Walker, P.A.**

** **

**RichardJ. Morgan*President & Chief Executive Officer**

** **

**WilfredT. Azar, III****President, Empire Management Services**

** **

**WilliamF. Chesley****President, W. F. Chesley RealEstate, Inc.**

** **

**CharlesF. Delavan, Esquire****Principal, Blumenthal, Delavan &Williams,P.A.**

** **

**EdwardB. Howlin, Jr.*****President, Howlin RealtyManagement, Inc.**

** **

**CharlesL. Hurtt, Jr., CPA*****President, Charles L. Hurtt, Jr., PA**

** **

**Milton D.Jernigan, Sr.****Private Investor and Retired Former Founder,Chairman and President, AAARentals, Inc.and AAA Tools, Inc.**

** **

**NicholasJ. Marino****President, Marino Transportation Services,LLC**

** **

**MichaelJ. Miller****Vice President, ConcreteGeneral, Inc. & TriM Leasing Corp**

 

**RobertR. Mitchell*Private Investor and Former President,Mitchell Business Equipment, Inc.**

 

**John A.Richardson, Sr.*****President, Crofton Bowling Center, FormerPresident, Branch Electric Supply Co., Inc.**

 

**Don E.Riddle, Jr.****Chairman & Chief Executive Officer,Homestead Gardens, Inc.**

 

**StephenC. Samaras****Owner, Zymotic, Inc. (Zachary’sJewelers)**

 

**GeorgeC. Shenk, Jr.*****President, Whitmore Group, Inc.**

** **

**LamontThomas*Former Executive Vice President & ChiefOperating Officer, CommerceFirst Bancorp,Inc.**

** **

**Dale R.Watson****President, Alpha EngineeringAssociates, Inc.**

** **

**Jerome A. Watts*****Private Investor and Former Owner, PlanManagement**

 

**J. Scott Wimbrow****Senior Vice President, MacKenzie CommercialReal Estate Services LLC**

 

 

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*Director of CommerceFirstBancorp, Inc.

### ** **

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# ** **

# **Officers of**

**CommerceFirstBank**

** **

**MichaelT. Storm****Executive Vice President &****Chief Operating Officer andChief Financial Officer**

** **

**ThomasL. Bolander****Senior Vice President**

** **

**W.Craig Engelhaupt****Senior Vice President**

** **

**CandaceM. Springmann****Vice President & CorporateSecretary**

** **

**MeloneeFleming, CCE****Vice President**

** **

**SusanM. Liebenthal****Assistant Vice President**

** **

**MeghanT. Stumpf****Assistant Vice President**

 

**James R.Baldwin****Senior Vice President**

 

**Penny L.Cantwell****Senior Vice President**

 

**GeorgeKapusta****Senior Vice President**

 

**Jean J.Barnes****Vice President**

 

**DavidSteinhoff****Vice President**

 

**IrmaRussellAssistant Vice President**

 

**RobertW. Smith IV****Loan Officer**

 

# **Locations of**

**CommerceFirstBank**

** **

**Annapolis****1804 West Street,Suite 200****Annapolis MD 21401**

** **

**BWI****910 Cromwell ParkDrive****Glen Burnie MD21061**

** **

**Severna Park****485 Ritchie Highway****Severna Park, MD 21146**

 

**Lanham****4451 ParliamentPlace****Lanham MD 20706**

 

**Old Dobbin Lane****6230 Old DobbinLane****Columbia MD 21045**

 

**TheCompany will provide, without charge, to any shareholder of record or anybeneficial owner of Common Stock, a copy of its 2008 Annual Report on Form 10-Kfiled with the Securities and Exchange Commission, upon the written request.Requests should be directed to Candace M. Springmann, Corporate Secretary, atthe Company’s executive offices at 1804 West Street, Suite 200, AnnapolisMD 21401.**

 

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